BLUEPRINT
: A BDO SERIES
Revenue Recognition
Under ASC 606
July
2023
REVENUE RECOGNITION UNDER ASC 606 2
TABLE OF CONTENTS
Introduction 4
ASC 606 in a Nutshell — The Five-Step Revenue Recognition Model 5
Other Key Concepts 7
Presentation and Disclosures 8
About the Blueprint 9
Chapter 1 — Scope 12
1.1 Overview 12
1.2 Scope and Scope Exceptions 12
1.3 Definition of a Customer 16
1.4 Contracts Partially Within the Scope of Other Standards 18
1.5 Interaction With Other Standards 20
1.6 Portfolio Approach 21
Chapter 2 — Step 1: Identify the Contract With a Customer 23
2.1 Overview 23
2.2 Definition of a Contract 24
2.3 Contract Enforceability and Termination Clauses 33
2.4 Contract Existence Criteria Are Not Met 38
2.5 Reassessment of Contract Existence Criteria 39
2.6 Combination of Contracts 41
Chapter 3 — Step 2: Identify the Performance Obligations in the Contract 44
3.1 Overview 44
3.2 Promises in Contracts With Customers 47
3.3 Distinct Goods or Services 52
3.4 Series of Distinct Goods or Services 67
3.5 Warranties 74
3.6 Practical Expedient for Nonpublic Franchisors 77
Chapter 4 — Step 3: Determine the Transaction Price 79
4.1 Overview 79
4.2 Determining the Transaction Price 80
4.3 Variable Consideration 81
4.4 Significant Financing Component 95
4.5 Noncash Consideration 101
4.6 Consideration Payable to a Customer 103
4.7 Nonrefundable Upfront Fees 112
4.8 Changes in the Transaction Price 113
REVENUE RECOGNITION UNDER ASC 606 3
Chapter 5 — Step 4: Allocate the Transaction Price to the Performance Obligations 116
5.1 Overview 116
5.2 Allocation Objective 118
5.3 Allocation Based on Standalone Selling Price 119
5.4 Allocation of a Discount 124
5.5 Allocation of Variable Consideration 127
Chapter 6 — Step 5: Recognize Revenue When or as the Performance Obligation is Satisfied 134
6.1 Overview 134
6.2 Satisfaction of Performance Obligations 135
6.3 Performance Obligations Satisfied Over Time 137
6.4 Measuring Progress Toward Complete Satisfaction of a Performance Obligation 155
6.5 Performance Obligations Satisfied at a Point in Time 167
6.6 Repurchase Agreements 169
6.7 Consignment Arrangements 175
6.8 Bill-and-Hold Arrangements 176
6.9 Customer Acceptance 178
Chapter 7 — Other Topics 179
7.1 Overview 179
7.2 Principal Versus Agent Considerations 179
7.3 Contract Modifications 193
7.4 Customer Options for Additional Goods or Services 202
7.5 Licensing 215
7.6 Onerous Contracts (Loss Contracts) 238
7.7 Contract Costs 243
Chapter 8 — Presentation and Disclosures 251
8.1 Overview 251
8.2 Presentation 251
8.3 Disclosures 257
Appendix A — Other BDO Blueprints 272
Contacts 273
REVENUE RECOGNITION UNDER ASC 606 4
INTRODUCTION
In May 2014, the Financial Accounting Standards Board (FASB) issued new revenue recognition guidance in ASU 2014-09,
Revenue from Contracts with Customers (ASC 606). ASC 606 sets out a single and comprehensive framework for
revenue recognition and addresses virtually all industries, including those that previously followed industry-specific
guidance, such as the real estate, construction, and software industries. The objective of ASC 606 is to establish the
principles that an entity should apply to report useful information to users of financial statements about the nature,
amount, timing, and uncertainty of revenue and cash flows arising from its contracts with customers. ASC 606 includes
an overall disclosure objective along with comprehensive disclosure requirements, which are principles-based (rather
than a checklist). An entity is required to make several judgments and estimates in applying the requirements of
ASC 606.
The revenue recognition project was one of several joint projects between the FASB and the International Accounting
Standards Board (IASB) aimed at converging U.S. generally accepted accounting principles (GAAP) and International
Financial Reporting Standards (IFRS). The U.S. and international standard setters had observed inconsistencies and
weaknesses in each of their respective accounting standards. Under U.S. GAAP, concepts for revenue recognition had
been supplemented with a broad range of industry-specific guidance, which had resulted in economically similar
transactions being accounted for differently. In IFRS, there was significant diversity in practice because existing
standards contained limited guidance for a range of significant topics, such as accounting for contracts with multiple
elements. Both the FASB and the IASB also stated that the prior disclosure requirements were inadequate, as they
often resulted in insufficient information for users of financial statements to understand the sources of revenue and
the key judgments and estimates made in its recognition. The information disclosed was also often “boilerplate” and
uninformative.
The Boards achieved their goal of reaching the same conclusions on all significant requirements for accounting for
revenue from contracts with customers with the issuance of ASC 606 and IFRS 15 Revenue from Contracts with
Customers in May 2014. After the issuance of the new accounting standards for revenue recognition, the FASB and IASB
formed the Joint Transition Resource Group for Revenue Recognition (TRG) to inform the Boards about potential
implementation issues and to assist stakeholders in understanding specific aspects of the new guidance. Because of
TRG deliberations, the FASB and IASB updated ASC 606 and IFRS 15, respectively, several times. Additionally, since the
implementation of ASC 606 by public business entities, the FASB is performing a post-implementation review of
ASC 606, which has resulted in additional amendments to ASC 606. While ASC 606 was converged with IFRS 15 upon
issuance, the subsequent amendments introduced differences in certain aspects of the two standards. The differences
relate to the following areas:
Revenue recognition for an arrangement that does not meet the criteria for a contract to exist under the revenue
standards
Promised goods or services that are immaterial within the context of a contract
Determination of performance obligations by franchisors
1
that are not public business entities
Shipping and handling activities
Presentation of sales taxes
Noncash consideration
Consideration payable to a customer (equity instruments)
In–substance sales of intellectual property (IP)
1
A franchisor is defined as “the party who grants business rights (the franchise) to the party (the franchisee) who will operate the
franchised business.”
REVENUE RECOGNITION UNDER ASC 606 5
Licensing:
• Determining the nature of an entity’s promise in granting a license of IP
• Contractual restrictions in a license and identification of performance obligations
• Renewals of licenses of IP
Disclosures
While the two standards are no longer fully converged, the differences are still relatively minor. Additional information
on revenue recognition for contracts with customers under IFRS 15 is available here.
ASC 606 IN A NUTSHELL — THE FIVE-STEP REVENUE RECOGNITION MODEL
FASB REFERENCES
ASC 606-10-05-1 through 05-4
ASC 606 establishes a single, comprehensive framework to determine how much revenue to recognize, and when. The
core principle is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in
an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or
services. An entity recognizes revenue when or as control over the goods or services is transferred to the customer.
Recognition of revenue is linked to changes in an entity’s assets and liabilities; this can be in the form of cash inflows,
increases in receivable balances, or decreases in liabilities that represent deferred revenue. All changes in those assets
and liabilities are recognized in profit or loss, other than those relating to transactions with owners (for example,
shareholders) in their capacity as such.
The core principle is applied in the following five steps (or the five-step revenue recognition model):
Step 1
Identify the
contract
Step 2
Identify separate
performance
obligations
Step 3
Determine the
transaction price
Step 4
Allocate the
transaction price
to performance
obligations
Step 5
Recognize
revenue when
(or as) each
performance
obligation is
satisfied
REVENUE RECOGNITION UNDER ASC 606 6
The following diagram provides a high-level summary of the five-step revenue recognition model, which is discussed in
detail in the following chapters:
Step 1
Identify the
Contract
Step 2
Identify Separate
Performance
Obligations
Step 3
Determine the
Transaction Price
Step 4
Allocate the
Transaction Price
to Performance
Obligations
Step 5
Recognize
Revenue When
(or as) Each
Performance
Obligation is
Satisfied
An entity identifies the contract with a customer for accounting purposes, which may
not be the same as the contract(s) for legal purposes. A contract is an agreement
(written, oral or implied by an entity’s customary business practices) that creates
enforceable rights and obligations between an entity and its customer.
An entity identifies performance obligations in the contract by analyzing its promises
to transfer goods or services to the customer. A performance obligation is a ‘distinct’
good or service (or a bundle of goods or services). A good or service (either
individually, or in combination with each other in a bundle) is distinct if the
customer can benefit from that good or service on its own or in combination with
other readily available resources and that good or service is separately identifiable
from other promises in the contract. An entity also considers the applicability of the
series guidance.
An entity determines the transaction price of the entire contract, including an
estimate of variable consideration if appropriate. The transaction price is the amount
recognized in revenue in Step 5. Other key aspects of this step include identifying
and adjusting the transaction price, if appropriate, for a significant financing
component, noncash consideration, or consideration payable to a customer.
An entity assesses when it satisfies each performance obligation (which may be at a
point in time or over time) by transferring a promised good or service to the
customer and recognizes revenue allocated to each performance obligation when (or
as) that performance obligation is satisfied. A good or service is transferred to the
customer when (or as) the customer obtains control over that good or service.
An entity allocates the transaction price among the different performance
obligations in the contract. The allocation is generally based on the relative
standalone selling price of each performance obligation with exceptions for certain
discounts and variable consideration; the allocation must be consistent with the
allocation objective. Determining the standalone selling price of each performance
obligation is a key aspect of this step.
REVENUE RECOGNITION UNDER ASC 606 7
The five-step revenue recognition model is applied to individual contracts. However, as a practical expedient, an
entity is permitted to apply the model to a portfolio of contracts (or performance obligations) with similar
characteristics if the entity reasonably expects that the effects would not differ materially from applying it to
individual contracts. For example, an entity may elect to apply this practical expedient when it may have many
contracts affected by a particular issue and an estimate is more appropriately made for the population of contracts as
a whole rather than for each contract individually. For example, for retail sales that give the customer a right of
return, it may be more appropriate to estimate the aggregate returns for a group of similar retail sale transactions,
rather than at the contract level (that is, rather than for each retail sale for which a right of return is granted).
BDO INSIGHTS — INDUSTRY-AGNOSTIC REVENUE RECOGNITION MODEL
ASC 606 is a comprehensive and industry-agnostic revenue recognition model. The adoption of ASC 606 resulted in
changes in revenue recognition policies for entities, but the amount and timing of revenue recognition did not
materially change for many entities. Regardless, an entity must make sure that its internal controls over financial
reporting comply with the requirements of ASC 606.
OTHER KEY CONCEPTS
Principal Versus Agent Considerations
ASC 606 provides guidance on principal versus agent assessments when a third party is involved in providing goods or
services to a customer. An entity is a principal, and thus recognizes revenue on a gross basis, if it controls a good or
service before transferring the good or service to the customer. An entity is an agent, and thus recognizes revenue on a
net basis, if it arranges for a good or service to be provided by another entity. The standard contains indicators and
examples to assist with the analysis.
ASC 606 clarifies the application of the principal versus agent guidance in the following areas:
Unit of account at which the principal versus agent determination is made
The control principle and principal versus agent indicators
Applying the control principle to certain types of transactions
BDO INSIGHTS — PRINCIPAL VERSUS AGENT ANALYSIS IS BASED ON CONTROL
The principal versus agent guidance is based on the concept of control. Control refers to an entity’s ability to direct
the use of and derive substantially all of the benefits from an asset. The control concept in ASC 606 includes the
elements of power and benefits.
Risks and rewards are merely indicators of control, which are not solely conclusive of whether control has
transferred.
Determining whether an entity controls a good or service before it is transferred to the customer requires the
application of professional judgment, based on the facts and circumstances.
Contract Modifications
ASC 606 includes a comprehensive model to account for modifications of contracts with customers. A contract
modification is a change in the scope or price of a contract approved by parties to the contract. This might be referred
to as a change order, variation, or an amendment. Accounting adjustments are only made for a contract modification
when either new enforceable rights and obligations are created, or existing ones are changed.
Depending on the nature of modifications, a contract modification may be accounted for under any one of the
following approaches:
a) A separate (and additional) contract with no adjustments to revenue recognized from the existing contract,
REVENUE RECOGNITION UNDER ASC 606 8
b) A termination of the existing contract and the creation of a new contract with prospective adjustments to
revenue recognized from the existing contract,
c) A continuation of the existing contract with cumulative catch-up adjustments to revenue recognized to date
from the existing contract,
d) A combination of the approaches described in b and c.
Customer Options for Additional Goods or Services
Customer options to acquire additional goods or services for free or at a discount come in many forms, including, sales
incentives, customer award credits (or points), contract renewal options, or other discounts on future goods or
services. ASC 606 provides guidance on accounting for a customer option to acquire additional goods or services based
on whether it is a material right, a renewal option or neither.
Licensing
ASC 606 contains special rules for recognizing revenue from licenses of IP. ASC 606 specifies that there are two types of
licenses of IP with different patterns for revenue recognition based on the nature of the license:
Symbolic IP license — It provides the customer with a right to access an entity’s IP throughout the license period,
and its utility is derived from the entity’s past or ongoing activities (for example, use of a brand). Revenue from
symbolic IP is recognized over time.
Functional IP license — It provides the customer with a right to use an entity’s IP as it exists at a point in time at
which the license is granted, and has significant standalone functionality (for example, a drug compound,
technology, or software product). Revenue from functional IP is generally recognized at a point in time.
Onerous Contracts (Loss Contracts)
ASC 606 does not provide specific guidance for onerous (loss) contracts with customers. However, certain guidance in
the prior revenue recognition guidance
2
continues to be applicable to certain onerous contracts with customers even
after the adoption of ASC 606. Given the lack of clear guidance, accounting for onerous contracts requires the
application of professional judgment, based on the facts and circumstances.
Contract Costs
ASC 340-40, Other Assets and Deferred Costs — Contracts with Customers, was issued concurrently with ASC 606 and
includes specific guidance on accounting for the incremental costs of obtaining and the costs incurred in fulfilling a
contract with a customer within the scope of ASC 606. Certain contract costs are initially recognized as an asset (that
is, deferred) and subsequently expensed on a systematic basis that is consistent with the pattern of transfer to the
customer of the good or service to which those costs relate.
PRESENTATION AND DISCLOSURES
Presentation
ASC 606 includes guidance on presenting contract assets, contract liabilities and receivables in the balance sheet for
contracts with customers. When either party to a contract has performed, an entity presents the contract in the
balance sheet as either a contract asset or a contract liability, depending on the relationship between the entity’s
performance and the customer’s payment. An entity presents any unconditional rights to consideration separately as a
receivable.
Disclosure Objective
ASC 606 includes an overall disclosure objective, which is for an entity to disclose information to enable users of
financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from
2
ASC 605-20, Revenue Recognition ― Services and ASC 605-35, Revenue Recognition ― Construction-Type and Production-Type
Contracts
REVENUE RECOGNITION UNDER ASC 606 9
contracts with customers. This objective is accompanied by comprehensive and principles-based disclosure
requirements about an entity’s:
Contracts with customers
Significant judgments, and changes in the judgments, made in applying ASC 606 to those contracts
Assets recognized for costs of obtaining and fulfilling those contracts
3
An entity is specifically required to consider both:
The level of detail necessary to satisfy the disclosure objective
Emphasis to be placed on each disclosure requirement
The purpose of the disclosure objective is to make sure that:
Information that users will find useful is not obscured by a large amount of insignificant detail
Items with sufficiently different characteristics are disaggregated and presented separately
BDO INSIGHTS — SEC STAFF CONSULTATIONS ON ASC 606
The SEC staff continues to receive consultations on revenue recognition matters, including identification of
performance obligations, principal versus agent considerations, identification of a customer and accounting for
consideration payable to a customer. The SEC staff will respect well-reasoned judgments grounded in facts and the
relevant accounting principles. Entities must also make sure that revenue recognition disclosures provide the
appropriate context to investors.
ABOUT THE BLUEPRINT
The Blueprint reflects the key aspects of the following accounting standards updates (referred to as ASC 606 in this
Blueprint):
ASU 2014-09, Revenue from Contracts with Customers (Topic 606)
ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date
ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting
Revenue Gross versus Net)
ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and
Licensing
ASU 2016-11, Revenue Recognition (Topic 605) and Derivatives and Hedging (Topic 815): Rescission of SEC Guidance
Because of Accounting Standards Updates 2014-09 and 2014-16 Pursuant to Staff Announcements at the March 3,
2016, EITF Meeting (SEC Update)
ASU 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical
Expedients
ASU 2016-20, Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers
ASU 2017-13, Revenue Recognition (Topic 605), Revenue from Contracts with Customers (Topic 606), Leases
(Topic 840), and Leases (Topic 842): Amendments to SEC Paragraphs Pursuant to the Staff Announcement at the
July 20, 2017, EITF Meeting and Rescission of Prior SEC Staff Announcements and Observer Comments (SEC Update)
ASU 2017-14, Income Statement—Reporting Comprehensive Income (Topic 220), Revenue Recognition (Topic 605)
and Revenue from Contracts with Customers (Topic 606) (SEC Update)
ASU 2018-18, Collaborative Arrangements (Topic 808): Clarifying the Interaction between Topic 808 and Topic 606
3
The disclosure requirements for assets recognized for costs of obtaining contracts with customers and fulfilling those contracts is
included in ASC 340-40.
REVENUE RECOGNITION UNDER ASC 606 10
ASU 2019-08, Compensation—Stock Compensation (Topic 718) and Revenue from Contracts with Customers
(Topic 606): Codification Improvements—Share-Based Consideration Payable to a Customer
ASU 2020-05, Revenue from Contracts with Customers (Topic 606) and Leases (Topic 842): Effective Dates for
Certain Entities
ASU 2021-02, Franchisors—Revenue from Contracts with Customers (Subtopic 952-606): Practical Expedient
This Blueprint includes detailed guidance and diagrams on analyzing and accounting for contracts with customers under
ASC 606. While this Blueprint does not include all requirements of ASC 606, it summarizes key aspects of ASC 606 that
are commonly considered in applying ASC 606. It also includes practical examples and interpretive guidance to assist
entities and practitioners in their continued application of ASC 606. The diagrams are provided to assist readers in
understanding various aspects of ASC 606. Revenue recognition for contracts with customers varies based on the
specific facts and circumstances of each contract and, therefore, may differ from the examples and insights provided
in the Blueprint.
The Blueprint has been divided into chapters that address key aspects of the revenue recognition standard. These
chapters are generally organized in the order in which an entity would apply ASC 606 and the questions that an entity
would need to answer as it proceeds through the evaluation. For example, the first two chapters discuss whether a
contract exists and is within the scope of ASC 606, and if so, a reader moves to the next chapter, which addresses
identification of the performance obligations in a contract with a customer, and so on. Other key aspects of ASC 606
related to specific issues in applying the five-step revenue recognition model have been grouped into one chapter
entitled “Other Topics,” which includes principal versus agent considerations, contract modifications, customer options
for additional goods and services, licensing, onerous contracts, and contract costs. Finally, there is a chapter discussing
the presentation and disclosure requirements in ASC 606.
The diagram below depicts how the chapters are organized.
The Blueprint focuses on revenue recognition for contracts with customers under ASC 606 only. More information on
revenue recognition for contracts with customers under International Financial Reporting Standards (IFRS) is available
here
.
Use of the Term “Public Entity” and “Nonpublic Entity”
ASC 606 includes certain modified requirements for an entity that does not meet the following definition of a public
business entity. Throughout this Blueprint, the term “public entity” refers to an entity that meets that definition and
the term “nonpublic entity” refers to an entity that does not meet that definition.
Presentation
and
Disclosures
Scope
Step 1:
Identify the
contract
with a
customer
Step 2:
Identify the
performance
obligations in
the contract
Step 3:
Determine
the
transaction
price
Step 4:
Allocate the
the performance
obligations
Step 5:
Recognize revenue
when or as the
performance
obligation is
satisfied
Other
Topics
REVENUE RECOGNITION UNDER ASC 606 11
FASB REFERENCES
ASC 606-10-20
Public business entity
A public business entity is a business entity meeting any one of the criteria below. Neither a not-for-profit entity
nor an employee benefit plan is a business entity.
It is required by the SEC to file or furnish financial statements or does file or furnish financial statements
(including voluntary filers), with the SEC (including other entities whose financial statements or financial
information are required to be or are included in a filing).
It is required by the Securities Exchange Act of 1934, as amended, or rules or regulations promulgated under that
Act, to file or furnish financial statements with a regulatory agency other than the SEC.
It is required to file or furnish financial statements with a foreign or domestic regulatory agency in preparation
for the sale of or for purposes of issuing securities that are not subject to contractual restrictions on transfer.
It has issued, or is a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an
over-the-counter market.
It has one or more securities that are not subject to contractual restrictions on transfer, and it is required by
law, contract, or regulation to prepare U.S. GAAP financial statements (including notes) and make them publicly
available on a periodic basis (for example, interim or annual periods). An entity must meet both conditions to
meet this criterion.
An entity may meet the definition of a public business entity solely because its financial statements or financial
information is included in another entity's filing with the SEC. In that case, the entity is only a public business entity
for purposes of financial statements that are filed or furnished with the SEC.
CAREFULLY EVALUATE THE DEFINITION OF “PUBLIC BUSINESS ENTITY”
The definition of “public business entity” is complex and encompasses more than just those entities whose stock
are listed on an exchange.
Future Standard Setting
FASB PROJECT ― POST-IMPLEMENTATION REVIEW FOR ASC 606
The FASB is performing a post implementation review of ASC 606 to consider whether further amendments to
ASC 606 are needed. However, as of the issuance date of this Blueprint, the FASB does not have an active standard-
setting project on its agenda related to revenue recognition.
REVENUE RECOGNITION UNDER ASC 606 12
CHAPTER 1 — SCOPE
1.1 OVERVIEW
ASC 606 applies to all entities and all contracts with customers to transfer goods or services arising from their ordinary
activities, except for contracts or transactions that are excluded from its scope. The definitions of “contract” and
“customer” establish the scope of ACS 606. ASC 606 includes guidance for a contract that is partially within the scope
of ASC 606 and partially within the scope of other U.S. GAAP.
1.2 SCOPE AND SCOPE EXCEPTIONS
FASB REFERENCES
ASC 606-10-15-2
The following contracts or transactions are excluded from the scope of ASC 606:
Lease contracts within the scope of ASC 842, Leases
4
Contracts within the scope of ASC 944, Insurance
Financial instruments and other contractual rights and obligations within the scope of ASC 320, Investments — Debt
Securities, ASC 321, Investments — Equity Securities, ASC 323, Investments — Equity Method and Joint Ventures,
ASC 325, Investments — Other, ASC 405, Liabilities, ASC 460, Guarantees (except certain warranties), ASC 470,
Debt, ASC 815, Derivatives and Hedging, ASC 825, Financial Instruments and ASC 860, Transfers and Servicing
Nonmonetary exchanges between entities in the same line of business to facilitate sales to customers or potential
customers
The scope exceptions in ASC 606 require that if specific guidance in other standards is applicable to a transaction, an
entity applies that guidance rather than the guidance in ASC 606. For example, guarantees (other than product
warranties) within the scope of ASC 460 are not within the scope of ASC 606 because ASC 460 provides specific
guidance for recognizing and measuring a guarantee liability. In other words, ASC 606 is applied as the residual
standard when a transaction is not within the scope of other U.S. GAAP.
4
See our Blueprint, Accounting for Leases Under ASC 842, for guidance on ASC 842.
Presentation
and
Disclosures
Scope
Step 1:
Identify the
contract
with a
customer
Step 2:
Identify the
performance
obligations in
the contract
Step 3:
Determine
the
transaction
price
Step 4:
Allocate the
transaction price to
the performance
obligations
Step 5:
Recognize revenue
when or as the
performance
obligation is
satisfied
Other
Topics
REVENUE RECOGNITION UNDER ASC 606 13
1.2.1 Nonmonetary Exchanges Between Entities in the Same Line of Business
FASB REFERENCES
ASC 606-10-15-2(e)
In industries with homogeneous products, it is common for entities in the same line of business to exchange products to
facilitate sales to customers or potential customers who may not be a party to that exchange. This may be done, for
example, to reduce transport costs, meet immediate inventory needs or otherwise facilitate a sale to the end
customer.
ASC 606-10-15-2(e) includes an example of two oil companies agreeing to exchange oil (or inventory) to fulfill customer
demand in different locations. In that example, because the oil being exchanged is an output of each oil company’s
ordinary activities, the counterparty to the exchange meets the definition of a customer (see Section 1.3 for discussion
of the definition of a customer). Applying ASC 606 to the exchange would have resulted in double recognition of
revenue for the same supplies of oil for each entity — once for the exchange of inventory between the two oil
companies, and thereafter for the sale of the inventory to the end customer. To avoid such gross up of revenues and
expenses, nonmonetary exchanges between entities in the same line of business to facilitate sales to customers or
potential customers are excluded from the scope of ASC 606. Such transactions may be within the scope of ASC 845,
Nonmonetary Transactions. If so, the oil companies in this example would apply the guidance in ASC 845 to account for
the exchange of oil between them and ASC 606 to recognize revenue for the sale of oil to the end customer.
BDO INSIGHTS — “LINE OF BUSINESS”
ASC 606 does not include any further guidance on interpreting “line of business” when assessing exchange
transactions, therefore judgment may be needed. We believe the scope exception is quite strictly drawn.
For example, consider whether an entity involved in mining diamonds is in the same line of business as an entity
mining rubies because they both operate in the same industry sub-sector (that is, mining of precious stones), or
whether they are in different lines of business because they mine different gemstones. We believe the entities are
not in the same line of business because rubies and diamonds are not acceptable substitutes for one another, unlike
in the example of oil in Section 1.1.1.
However, even if the transaction is within the scope of ASC 606, it is necessary to understand the commercial
substance of an exchange transaction before concluding whether the exchange generates revenue. Further, even if
there is commercial substance to the exchange, each entity might be acting as an agent for the other in the
ultimate sale to the other entity’s end customer, meaning that they are providing agency services to each other.
This conclusion would impact the measurement of revenue, which would then be based on the provision of the
agency services, not the gross value of the exchanged goods or services.
Reaching a conclusion about whether two entities are in the same line of business, whether an exchange between
the entities has commercial substance, and whether an entity is acting as an agent for the other entity, requires the
application of professional judgment, based on the facts and circumstances.
The TRG clarified when certain transactions are subject to one of the scope exceptions during its deliberations.
Following is a summary of those discussions:
REVENUE RECOGNITION UNDER ASC 606 14
TRG DISCUSSIONS — ARRANGEMENTS BETWEEN FINANCIAL INSTITUTIONS AND CREDIT CARDHOLDERS
At the July 2015 meeting, the TRG discussed whether certain arrangements between financial institutions and
credit cardholders are within the scope of ASC 606. Although some income streams, such as interest charges on late
payments, are not within the scope of ASC 606, questions had been raised regarding periodic or annual fees that are
not dependent on the amount of credit available or the use of the credit card or ancillary services, such as access to
airport lounges and reward programs.
The FASB staff concluded that entities should continue to account for services exchanged for credit card fees under
ASC 310 (now superseded by ASC 326, Financial Instruments — Credit Losses) rather than ASC 606. Additionally, if
the credit card arrangement is within the scope of ASC 310 (now superseded by ASC 326), then the associated
reward program would be as well. However, the FASB staff stated that ASC 310 (now superseded by ASC 326) would
not apply if the issuance of a card is incidental to the arrangement.
TRG DISCUSSIONS — INCOME FROM SERVICING AND SUB-SERVICING ACTIVITIES
At the April 2016 meeting, the TRG discussed whether income from servicing and sub-servicing activities (for
example, servicing mortgage loans) are within the scope of ASC 606. The TRG stated that while ASC 860 includes
detailed guidance on the initial recognition and subsequent measurement of servicing assets and liabilities, it does
not include explicit guidance describing the revenue recognition of servicing fees.
However, the FASB staff concluded that the subsequent measurement guidance in ASC 860 provides sufficient
implicit guidance on accounting for servicing cash flows and, therefore, the accounting for servicing and sub-
servicing revenues is within the scope of ASC 860 rather than ASC 606.
TRG DISCUSSIONS — DEPOSIT-RELATED FEES
At the April 2016 meeting, the TRG discussed whether deposit-related fees, such as monthly service fees, ATM
usage fees and foreign exchange fees, are within the scope of ASC 405, which governs the accounting for the
related deposit liability. The FASB staff concluded that ASC 405 only addresses the accounting for the deposit
liability and does not contain an accounting framework for recognizing revenue from deposit-related transactions.
Therefore, deposit-related fees are within the scope of ASC 606.
REVENUE RECOGNITION UNDER ASC 606 15
TRG DISCUSSIONS — INCENTIVE-BASED CAPITAL ALLOCATIONS, SUCH AS CARRIED INTEREST
At the April 2016 meeting, the TRG discussed whether incentive-based performance fees through an allocation of
capital (often referred to as a “carried interest”) are within the scope of ASC 606. Some entities, particularly asset
managers, receive incentive-based performance fees by way of an allocation of capital from investment funds under
management as compensation for services and performance in managing the funds.
Multiple TRG members, the FASB staff and Board members concluded that those fees are within the scope of
ASC 606 because they are compensation for services provided and, hence, form a revenue transaction.
However, some TRG members held an alternate view that a carried interest could be considered an equity
arrangement outside the scope of ASC 606 because it is, in form, an ownership interest in an entity. Under that
alternate view, an entity receiving a carried interest would apply the consolidation model in ASC 810, equity
method of accounting in ASC 323, or other U.S. GAAP to determine the appropriate accounting treatment for the
ownership interest held in another entity.
At that meeting, the SEC staff observer indicated that the SEC staff would accept treatment of carried interest as a
revenue transaction within the scope of ASC 606. However, the SEC staff also stated that there may also be a basis
for applying an ownership model. If an entity were to apply an ownership model, then the SEC staff would expect
full application of the ownership model, including an analysis of the consolidation model under ASC 810, the equity
method of accounting under ASC 323, or other relevant guidance. See our BDO Knows: Variable Interest Entities
for guidance on applying ASC 810.
BDO INSIGHTS — ACCOUNTING FOR CARRIED INTERESTS
We believe determining whether to account for a carried interest as a revenue transaction or an equity
arrangement is an accounting policy election that must be consistently applied, and fully disclosed. Accounting for
carried interests requires the application of professional judgment, based on the facts and circumstances.
1.2.2 Scope of ASC 606
The definitions of contract and customer establish the scope of ASC 606 — this is illustrated in the following diagram.
The definition of a customer is discussed in Section 1.3 and the definition of a contract (the contract existence
criteria) is discussed in Section 2.2.
Recognize revenue under
ASC 606
Revenue cannot be
recognized
(See Section 2.4)
Revenue is Recognized for a Contract With a Customer
Are the contract
existence criteria met?
Is the counterparty a
“customer”?
Yes
No
No
Apply other U.S. GAAP
Yes
REVENUE RECOGNITION UNDER ASC 606 16
1.3 DEFINITION OF A CUSTOMER
FASB REFERENCES
ASC 606-10-20, ASC 606-10-15-2A and 15-3
A customer is “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.”
1.3.1 Ordinary Activities
ASC 606 does not define the term “ordinary activities,” which was derived from the definitions of revenue in the
FASB’s conceptual framework. The definition of revenue in Statement of Financial Accounting Concepts No. 6,
Elements of Financial Statements, (Concepts Statement 6) refers to the notion of an entity’s “ongoing major or central
operations.”
In December 2021, the FASB replaced the definition of revenue in Concepts Statement 6 with a new definition in
Statement of Financial Accounting Concepts No. 8, which removed the reference to the notion of an entity’s “ongoing
major or central operations.” In making that change, the FASB concluded that delivering or producing goods and
rendering services are primary factors in distinguishing revenue from gains, regardless of whether they are considered
major or central to an entity. Despite that subsequent change in the conceptual definition of revenue since the
issuance of ASC 606 in 2014, in practice, entities continue to consider the notion of “ongoing major or central
operations” because that was the thought process behind the FASB using the term “ordinary activities” in defining the
customer under ASC 606.
The definition of a customer was included in the standard to enable entities to distinguish contracts for which revenue
is recognized under ASC 606 (that is, contracts with customers) from contracts that are not within the scope of
ASC 606. Revenue from transactions within the scope of ASC 606 is derived from contracts with customers entered by
an entity for the sale of goods or services arising from its ordinary activities.
Revenue from a transaction that does not arise from a contract with a customer is not within the scope of ASC 606. For
example, receipts of dividends, sales of nonfinancial assets (such as excess properties), nonexchange transactions
(including receipts of government assistance or donations) are not within the scope of ASC 606. Those transactions are
recognized in accordance with other U.S. GAAP.
BDO INSIGHTS — DETERMINING WHETHER INCOME IS FROM “ORDINARY ACTIVITIES”
Judgment may be required to determine whether an income generating activity is an ordinary activity under
ASC 606 in certain circumstances. For example, an entity that starts selling new products or services would need to
determine whether and at what point the new offering becomes its ordinary activity or part of its ongoing major or
central operations. Reaching a conclusion about whether an income generating activity is an ordinary activity
requires the application of professional judgment, based on the facts and circumstances.
REVENUE RECOGNITION UNDER ASC 606 17
FASB PROJECT ― ACCOUNTING FOR GOVERNMENT GRANTS
The FASB has a research project on accounting for government grants received. U.S. GAAP currently does not
include specific guidance on recognition and measurement of government grants received by for-profit entities.
Entities can analogize to the guidance in IAS 20, Accounting for Government Grants and Disclosure of Government
Assistance, ASC 450-30, Gain Contingencies, or ASC 958-605, Not-for-Profit Entities — Revenue Recognition —
Contributions, on revenue recognition by not-for-profit entities to determine the accounting for government grants
received.
ASC 610-20, Other Income — Gains and Losses from the Derecognition of Nonfinancial Assets, includes guidance on
recognition of gains or losses from derecognition of nonfinancial assets and in-substance nonfinancial assets transferred
to counterparties that are not customers, which typically results in a net presentation of the gain or loss outside
revenue.
5
ASC 610-20 generally requires applying the revenue recognition principles in ASC 606 to contracts within the
scope of ASC 610-20.
EXAMPLE 1-1: SALE TO A COUNTERPARTY THAT IS NOT A CUSTOMER
An entity generates revenue by manufacturing and selling containers. The entity enters a contract to transfer one of
the machines from its manufacturing facility to a counterparty in exchange for $10,000.
The entity considers whether the sale of machinery is within the scope of ASC 606. The entity observes that it does
not ordinarily generate revenue by selling machinery. Rather, it employs the machinery (that is, a fixed asset) in its
facility to manufacture containers for sale. The entity concludes that the sale of machinery is not an output of its
ordinary activities. Therefore, the entity determines that the counterparty in the contract for the sale of machinery
is not a customer, and accordingly ASC 606 is not applicable to the transaction. That is, the entity does not
recognize or present the $10,000 it receives as revenue from the sale of the machinery.
The entity considers the guidance in ASC 610-20 on transfer of nonfinancial assets to determine the appropriate
accounting and presentation of the sale of machinery.
1.3.2 More Than One Customer in a Contract
A revenue transaction may have more than one customer such that an entity may be transferring goods or services that
are an output of its ordinary activities to more than one party. For example, an entity that is acting as an agent may
conclude that both the principal in the arrangement and the end customer are its customers for different aspects of
the arrangement. See Section 7.2 for discussion of the principal versus agent analysis.
PRINCIPAL VERSUS AGENT ANALYSIS ― IDENTIFICATION OF THE CUSTOMER(S)
Careful analysis is required to identify an entity’s customer(s) in revenue transactions that include more than two
parties. Correct identification of customer(s) is important because it affects the identification of consideration
payable to a customer, which, under certain conditions, is recognized as a reduction of revenue (see Section 4.6 for
discussion on consideration payable to a customer).
5
Based on a reference in ASC 610-20-45-1 to ASC 360-10-45-5 for presentation of a gain or loss recognized on the sale
of a long-lived asset.
REVENUE RECOGNITION UNDER ASC 606 18
1.4 CONTRACTS PARTIALLY WITHIN THE SCOPE OF OTHER STANDARDS
FASB REFERENCES
ASC 606-10-15-4
An entity applies the approach summarized in the following diagram to account for a contract that is partially within
the scope of ASC 606 and partially within the scope of other U.S. GAAP:
If one or more other standards specify how to separate or measure the parts of a contract that they address, then an
entity applies the separation and measurement guidance in those other standards to determine the portion of the
transaction price that is excluded from ASC 606. If other standards do not address how to separate or measure the
parts of the contract that they address, then the guidance in ASC 606 for separating and measuring parts of the
contract (see Chapter 5 for related discussion) is used to determine how to allocate the transaction price between the
element(s) subject to other standards and the element(s) subject to ASC 606.
EXAMPLE 1-2: CONTRACT PARTIALLY WITHIN THE SCOPE OF ASC 606 — LEASE OF EQUIPMENT WITH
MAINTENANCE SERVICE
An entity leases a bulldozer, a truck, and a crane to a customer for three years. The entity also agrees to maintain
each piece of equipment throughout the lease term. Assume that the leases meet the definition of a lease under
ASC 842 and, therefore, the contract is within the scope of ASC 842.
In accordance with ASC 842-10-15-31, the entity separates the lease and non-lease components (maintenance
services) in the contract and applies the requirements in ASC 842 to the lease components. While non-lease
components are not within the scope of ASC 842, ASC 842 includes guidance on allocating the consideration in a
Parts of the contract not addressed by
other U.S. GAAP
Apply the requirements of ASC 606 to
the transaction price allocated to these
parts of the contract.
Yes
No
Does other U.S. GAAP specify how to
separate or initially measure one (or
more) parts of the contract?
Apply the separation or measurement guidance in other U.S. GAAP to allocate the
transaction price relating to parts of the contract addressed by other U.S. GAAP:
Parts of the contract addressed by other
U.S. GAAP
Apply the requirements of other U.S.
GAAP to the transaction price allocated
to these parts of the contract.
Apply the requirements of
ASC 606 to the entire
contract.
REVENUE RECOGNITION UNDER ASC 606 19
contract to each separate lease and non-lease component of the contract. The entity applies ASC 606 only to the
consideration received from the customer that is allocated to the maintenance services
6
.
1.4.1 Contributions Received by Not-for-Profit Entities
FASB REFERENCES
ASC 606-10-20 and ASC 958-605-20
ASC 606 requires an entity to consider the guidance in ASC 958-605 when determining whether a transaction is a
contribution within the scope of ASC 958-605 or a transaction within the scope of ASC 606. Contributions received from
donors are not specifically outside the scope of ASC 606. However, in practice, those contributions are typically not
within the scope of ASC 606 because ASC 606 defines revenue as “inflows or other enhancement of assets of an entity
or the settlement of its liabilities (or a combination of both) from delivering or producing goods, rendering services or
other activities that constitute the entity’s ongoing and major activities.” On the other hand, a contribution is defined
in ASC 958-605 as “an unconditional transfer of cash or other assets to an entity or a settlement or cancellation of its
liabilities in a voluntary nonreciprocal transfer by another entity acting other than as an owner.” In other words,
revenue is derived from a reciprocal transfer between parties in which the parties are expecting to exchange similar
value, whereas a contribution is voluntary and nonreciprocal. Because of these differences in the nature of revenue
and contributions, a contribution received by a not-for-profit (NFP) is outside the scope of ASC 606.
Nevertheless, an NFP may engage in activities that are considered exchanges or revenue transactions with customers
and thus are within the scope of ASC 606. An NFP must evaluate its contracts to determine if they include both
contributions and exchange transactions. A contribution component is outside the scope of ASC 606 and, consequently,
contracts that have both components are required to be separated. For example, the following arrangements may be
partially or wholly within the scope of ASC 606:
Memberships
Subscription
Sale of products and services
Royalty agreements
Sponsorships
Conferences and seminars
Tuition
Advertising
Licensing
Federal and state grants and contracts
TRG DISCUSSIONS — CONTRACTS PARTIALLY WITHIN THE SCOPE OF ASC 606 — PAYMENT RECEIVED BY AN
NFP
In certain circumstances, a payment received by an NFP may represent both a contribution and a reciprocal transfer
of goods or services. For example, a service organization may charge an annual membership fee that, in addition to
providing funding to support the organization’s programs, grants the member the right to receive a monthly or
quarterly magazine.
6
See our Blueprint, Accounting for Leases Under ASC 842, for guidance on ASC 842, including a practical expedient that allows
lessors to combine lease and non-lease components and account for the combined component under ASC 606 or ASC 842 based on
whether the lease or non-lease component is predominant.
REVENUE RECOGNITION UNDER ASC 606 20
At its March 2015 meeting, the TRG discussed whether contributions are within the scope of ASC 606. The TRG
observed that because contributions represent nonreciprocal transfers, they do not represent the sale of goods or
services and thus are not within the scope of ASC 606.
However, the FASB staff acknowledged that if an NFP transfers a good or service in a reciprocal transfer, that
arrangement is accounted for under ASC 606. Therefore, the annual membership fee in this example represents a
contract that is partially within the scope of ASC 606 and partially within the scope of ASC 958-605.
Additionally, because ASC 958-605-55 contains specific guidance for separating and initially measuring contribution
and exchange portions of a payment, the NFP applies that guidance to allocate the payment received. Therefore,
the NFP determines the fair value of the exchange portion of the transaction, with the residual reported as
contributions.
1.5 INTERACTION WITH OTHER STANDARDS
Consequential amendments were made to the existing requirements of other standards for the recognition of gain or
loss on the transfer of some non-financial assets that are not an output of an entity’s ordinary activities (such as
property, plant, and equipment and intangible assets) to be consistent with the requirements in ASC 606. See
Section 1.3.1 for discussion on ASC 610-20.
Additionally, ASC 606 specifies the interaction with certain other standards as discussed below.
1.5.1 Deferred Costs From Contracts With Customers
FASB REFERENCES
ASC 606-10-15-5
For contracts with customers that are within the scope of ASC 606, an entity applies ASC 340-40, which provides
guidance on accounting for the costs incurred to obtain or fulfill a contract with a customer if those costs are not
within the scope of other U.S. GAAP (see Section 7.7).
1.5.2 Collaborative Arrangements
FASB REFERENCES
ASC 606-10-15-3 and ASC 808-10-15-5A through 15-5C
ASC 808-10-20
A collaborative arrangement is defined as “a contractual arrangement that involves a joint operating activity.
These arrangements involve two (or more) parties that meet both of the following requirements:
They are active participants in the activity.
They are exposed to significant risks and rewards dependent on the commercial success of the activity.”
ASU 2018-18 amended ASC 606 and ASC 808, Collaborative Arrangements, to clarify the interaction between the two
standards. Certain transactions between collaborative arrangement participants are within the scope of ASC 606 when
the collaborative arrangement participant is a customer in the context of a unit of account. In those situations, all of
ASC 606 guidance is applied, including recognition, measurement, presentation, and disclosure requirements.
REVENUE RECOGNITION UNDER ASC 606 21
ASC 808 includes guidance on unit of account (that is, whether an activity is a distinct good or service) that is aligned
with the guidance in ASC 606. That guidance is used to determine whether the collaborative arrangement, or a part of
the arrangement, is within the scope of ASC 606.
An entity is precluded from presenting income from a collaborative arrangement with revenue recognized under
ASC 606 unless:
The collaborative arrangement participant is a customer
The transaction with a collaborative arrangement participant is directly related to sales to third parties
7
BDO INSIGHTS — DETERMINING WHETHER A RESEARCH AND DEVELOPMENT ARRANGEMENT IS WITHIN THE SCOPE
OF ASC 606
For life sciences entities, research and development (R&D) arrangements are often complex, involve multiple
deliverables and various types of consideration, and span several years. The analysis of whether a counterparty to
an arrangement is a customer (as defined in ASC 606) is important when evaluating whether “reimbursements” or
“funded R&D” can be accounted for as revenue from a contract with a customer. In answering this question, an
entity determines whether the reimbursement relates to goods or services that are an output of the entity’s
ordinary activities. If the entity’s ordinary activities are performing R&D, then it is likely that the relationship
between the entity and the counterparty is an entity-customer relationship, and the consideration would be
recognized as revenue under ASC 606. Reaching a conclusion about whether an R&D arrangement is within the scope
of ASC 606 requires the application of professional judgment, based on the facts and circumstances
COLLABORATIVE ARRANGEMENT
A collaborative arrangement within the scope of ASC 808 is also within the scope of ASC 606 if the counterparty is a
customer as defined in ASC 606. In that scenario, an entity applies the guidance in both ASC 606 and ASC 808 to that
transaction. Specifically, an entity would apply the following guidance:
Recognition, measurement, presentation and disclosure requirements in ASC 606
Disclosure requirements in ASC 808
1.6 PORTFOLIO APPROACH
FASB REFERENCES
ASC 606-10-10-4
ASC 606 specifies the accounting for an individual contract with a customer. Entities often have many similar contracts
for which applying the standard on a contract-by-contract basis might be impractical. As a practical expedient, an
entity may apply the guidance in ASC 606 to a portfolio of contracts (or performance obligations) with similar
characteristics if the entity reasonably expects that the effects on the financial statements of applying the guidance to
7
ASC 808-10-55-11 through 55-14 includes a related example.
REVENUE RECOGNITION UNDER ASC 606 22
the portfolio would not differ materially from applying the guidance to the individual contracts (or performance
obligations) within that portfolio. See Chapter 3 for discussion on performance obligations.
When accounting for a portfolio of contracts with customers, an entity uses estimates and assumptions that reflect the
size and composition of the portfolio. Entities often apply the portfolio approach when many contracts are affected by
a particular issue (for example, when an estimate is more appropriately made for the population of contracts rather
than for each contract individually). For example, for retail sales that give the customer a right of return, it may be
more appropriate to estimate the aggregate returns for a group of similar retail sale transactions, rather than at the
contract level (that is, rather than for each retail sale for which a right of return is granted).
1.6.1 Evaluation of Whether Portfolio Approach Results in a Materially Different Outcome
FASB REFERENCES
ASC 606-10-55
ASC 606 does not provide specific guidance on whether or when the application of the portfolio approach is appropriate
or how to determine whether the effects of applying the portfolio approach would differ materially from applying
ASC 606 on a contract-by-contract basis.
However, ASC 606 illustrates the portfolio approach in an example related to a right of return (see Section 4.3.8 for
discussion on a sale with a right to return). That example includes a fact pattern in which an entity applies the
portfolio approach to 100 contracts, each of which includes the sale of one product at the same price and with the
same terms. Additionally, the Background Information and Basis for Conclusions (BC) 293 of ASU 2014-09 states that
using the portfolio approach could simplify the application of the guidance on allocation of transaction price (in Step 4)
for a group of similar contracts in certain circumstances. However, BC69 of ASU 2014-09 states that the FASB did not
intend for an entity to quantitatively evaluate each outcome and, instead, an entity can use a reasonable approach to
determine the portfolios that would be appropriate for its types of contracts.
BDO INSIGHTS — PORTFOLIO APPROACH
While the portfolio approach is a more practical and cost-effective approach to applying the standard, entities need
appropriate processes and controls in place to apply it. Additionally, an entity needs to apply judgment in:
Selecting the size and composition of the portfolio and determining whether the contracts within a portfolio
have similar characteristics. Characteristics of a contract would include considerations for:
• Type of customer
• Goods or services (or performance obligations) transferred
• Pricing
• Any other pertinent terms
Evaluating qualitatively the effects on the financial statements of applying ASC 606 on a portfolio basis rather
than on a contract-by-contract basis.
Reassessing the appropriateness of the level of portfolio or use of portfolio approach for subsequent changes in
the characteristics of contracts.
Reaching a conclusion about when and how to appropriately use the portfolio approach requires the application of
professional judgment, based on the facts and circumstances.
REVENUE RECOGNITION UNDER ASC 606 23
CHAPTER 2 — STEP 1: IDENTIFY THE
CONTRACT WITH A CUSTOMER
2.1 OVERVIEW
Once an entity determines that it is transferring goods or services arising from its ordinary activities to a customer in a
transaction within the scope of ASC 606, the first step in applying the five-step revenue recognition model is to identify
the contract(s) with a customer. A contract is defined as an agreement between two or more parties that creates
enforceable rights and obligations. The standard includes five contract existence criteria, each of which must be met
for a contract with a customer to exist. If the contract existence criteria are met, revenue from the contract is
accounted for under the five-step revenue recognition model in ASC 606. If any one of the contract existence criteria
are not met, ASC 606 includes guidance on reassessing whether the contract existence criteria are subsequently met
and accounting for consideration received from a customer before the contract existence criteria are met.
ASC 606 also includes contract combination guidance to determine when an entity should combine two or more
contracts and account for them as a single contract.
The following diagram provides an overview of Step 1:
Presentation
and
Disclosures
Scope
Step 1:
Identify the
contract
with a
customer
Step 2:
Identify the
performance
obligations in
the contract
Step 3:
Determine
the
transaction
price
Step 4:
Allocate the
transaction price to
the performance
obligations
Step 5:
Recognize revenue
when or as the
performance
obligation is
Other
Topics
REVENUE RECOGNITION UNDER ASC 606 24
2.2 DEFINITION OF A CONTRACT
FASB REFERENCES
ASC 606-10-20
A contract is defined as “an agreement between two or more parties that creates enforceable rights and
obligations.”
2.2.1 Enforceable Rights and Obligations
FASB REFERENCES
ASC 606-10-25-2
An agreement does not need to be written to create legally enforceable rights and obligations. Enforceability of the
rights and obligations in a contract is a matter of law. Determining whether a contractual right or obligation is
enforceable is considered within the context of the relevant legal framework (or equivalent framework) to make sure
that the parties’ rights and obligations are upheld. A contract with a customer for accounting under ASC 606 need not
be the same as a contract for legal purposes.
The practices and processes for establishing contracts with customers vary across legal jurisdictions, industries, and
entities. Additionally, business practices may vary within an entity, for example, depending on the class of customer or
Combine the
contract with
other contract(s)
to apply the five-
step revenue
recognition
model.
Does a contract with a customer exist?
Does the contract combination
guidance apply?
Has the entity
received
consideration from
customer?
Account for the
contracts
separately under
the five-step
revenue
recognition
model.
* Continuously reassess the
arrangement to determine whether the contract existence criteria are subsequently met
**
See Section 2.4.2 for discussion on consideration received from customer before the contract existence criteria are met.
No*
No accounting
impact
Are contract
existence criteria
subsequently met?
Yes
Apply the five-step
revenue recognition
model to the
contract.
Have one of the
events in ASC 606-
10-25-7 occurred?**
Recognize
revenue**
Recognize a
liability**
Yes
No
Yes
No
No
No
Yes
Yes
REVENUE RECOGNITION UNDER ASC 606 25
the nature of the goods or services. Written, oral or implied contracts with customers could create enforceable rights
and obligations depending on legal jurisdictions, industries, or customary business practices. An entity must consider
those factors in determining whether and when an agreement with a customer creates enforceable rights and
obligations.
In many cases, the contract that is accounted for separately under ASC 606 is the individual contract negotiated with
the customer. However, the structure and scope of a contract can vary depending on how the parties to the contract
record their agreement. For instance, there may be legal or commercial reasons for the parties to use more than one
contract to document the sale of related goods or services or to use a single contract to document the sale of
unrelated goods or services. See Section 2.6 for a discussion on when to combine contracts.
Although there must be legally enforceable rights and obligations between parties for a contract to exist under
ASC 606, a promise within the contract is not necessarily required to be legally enforceable to be a performance
obligation. A promise within the contract could arise from the customer having a valid expectation that the entity will
transfer goods or services to the customer even though that promise is not enforceable. See Chapter 3 for discussion on
identifying promises and performance obligations in a contract.
2.2.2 Contract Existence Criteria
FASB REFERENCES
ASC 606-10-25-1 and ASC 606-10-32-21
To determine whether enforceable rights and obligations exist in an arrangement with a customer, an entity evaluates
the following five contract existence criteria. Contract inception is the date at which all five contract existence
criteria are met. ASC 606 is applied to contracts with customers only when all five criteria are met.
BC33 of ASU 2014-09 states that in establishing the contract existence criteria to complement the definition of a
contract, the FASB reasoned that when any of those criteria are not met, it is questionable whether the contract
establishes enforceable rights and obligations between an entity and its customer.
Contract Existence Criteria
The contract has
been approved and
the parties are
committed to
perform their
obligations.
Each party’s rights
regarding the goods
or services to be
transferred can be
identified.
The payment terms
for the goods or
services to be
transferred can be
identified.
The contract has
commercial
substance.
Collectibility of
substantially all of
the considered is
considered
probable.
REVENUE RECOGNITION UNDER ASC 606 26
2.2.2.1 The Contract Has Been Approved and The Parties Are Committed to Perform Their Obligations
FASB REFERENCES
ASC 606-10-25-1(a)
For a contract to be enforceable, the parties to the contract must approve the contract and commit to performing
their respective obligations under the contract. An entity considers all relevant facts and circumstances in assessing
whether the parties intend to be bound by the terms and conditions of the contract. The form of the contract does
not, in and of itself, determine whether the parties have approved the contract. Depending on customary business
practices, in some cases the parties to an oral or implied contract may have agreed to fulfill their respective
obligations while in other cases, a written contract may be required to determine that the parties to the contract have
approved it.
BDO INSIGHTS — WHETHER THE PARTIES ARE COMMITTED TO PERFORM THEIR OBLIGATIONS
Determining whether an entity and its customer are committed to fulfilling their respective obligations may require
judgment. For example, BC36 of ASU 2014-09 describes a contract that requires the customer to purchase a
minimum quantity of goods from the entity each month, but the customer’s past practice indicates that the
customer is not committed to always purchasing the minimum quantity each month, and the entity does not enforce
the requirement to purchase the minimum quantity. In that example, the first contract existence criterion, whether
the contract has been approved and the parties are committed to performing their obligations, could still be
satisfied if there is evidence that demonstrates that the customer and the entity are substantially committed to the
contract. The FASB stated that requiring all rights and obligations to be fulfilled would have inappropriately
resulted in no recognition of revenue for some contracts in which the parties are substantially committed to the
contract.
Reaching a conclusion about whether the parties are committed to perform their obligations requires the
application of professional judgment, based on the facts and circumstances.
2.2.2.2 Each Party’s Rights Regarding the Goods or Services Transferred Can Be Identified
FASB REFERENCES
ASC 606-10-25-1(b)
For a contract to be enforceable, an entity must be able to identify each party’s rights regarding the goods or services
transferred. This criterion was included because an entity would not be able to assess the transfer of goods or services
for revenue recognition under the five-step revenue recognition model if it could not identify each party’s rights
regarding those goods or services in Step 2.
REVENUE RECOGNITION UNDER ASC 606 27
EXAMPLE 2-1: MASTER SUPPLY AGREEMENT
An entity enters a master supply agreement (MSA) with a customer to supply a product according to the terms and
conditions (for example, duration of the MSA, pricing information, payment terms, return rights) specified in the
MSA. The MSA states that the customer will place a purchase order (PO) for the quantity of products needed
throughout the term of the MSA, and that each PO will be subject to the terms and conditions of the MSA. The MSA
itself does not obligate the entity to transfer a specific number of products to the customer or the customer to
purchase and pay for a specific number of products. One month after the execution of the MSA, the customer
submits a PO specifying the number of products it wishes to purchase.
The MSA and PO collectively create enforceable rights and obligations for the entity to transfer the products under
the PO to the customer and the customer to purchase those products and pay according to the pricing information
and payment terms in the MSA. Therefore, assuming the customer has the intent and ability to pay amounts due
under the PO, the MSA and PO together meet the definition of a contract.
EXAMPLE 2-2: MSA WITH MINIMUM VOLUME GUARANTEE
An entity enters an MSA with a customer to supply a product according to the terms and conditions (for example,
duration of the MSA, pricing information, payment terms, return rights) specified in the MSA. The MSA provides that
the customer will place Pos for the quantity of products needed throughout the term of the MSA, and that each PO
will be subject to the terms and conditions of the MSA. The MSA includes a minimum volume guarantee such that
the entity guarantees the supply of the product, and the customer agrees to purchase a minimum volume of the
product during the contract term. If the customer fails to purchase the minimum volume required, the entity has
the right to charge a penalty equal to the price of the shortfall.
The MSA itself obligates the entity to transfer a specific number of products to the customer and the customer to
purchase and pay for a specific number of products. Therefore, the MSA itself may create enforceable rights and
obligations for the entity to transfer the minimum volume of the product to the customer and the customer to
purchase the minimum volume of the product and pay for it according to the pricing information and payment terms
in the MSA.
See Example 2-3 for a discussion of the effects of an entity’s past practice in determining whether a contractually
specified minimum volume is substantive.
EXAMPLE 2-3: MSA WITH MINIMUM VOLUME GUARANTEE THAT HAS NOT BEEN ENFORCED IN THE PAST
Assume the same facts in Example 2-2 except that the entity’s past practice indicates that if the customer does not
purchase the specified minimum volume in the MSA, the entity may not enforce such purchase.
Even though the MSA includes minimum volume guarantee, the past practice of not enforcing it may indicate that
the entity and the customer are not committed to that minimum volume. In other words, the minimum guarantee
may not be substantive in this fact pattern. As a result, the MSA may not create enforceable rights and obligations
on its own, but rather the MSA when combined with a PO would collectively create enforceable rights and
obligations for the parties to the contract.
REVENUE RECOGNITION UNDER ASC 606 28
2.2.2.3 The Payment Terms for the Goods or Services Transferred Can Be Identified
FASB REFERENCES
ASC 606-10-25-1(c)
For a contract to be enforceable, an entity must be able to identify the payment terms for the goods or services
transferred. This criterion was included because an entity would not be able to determine the transaction price in
Step 3 of the five-step revenue recognition model if it could not identify the payment terms in exchange for the
promised goods or services.
In certain industries, for example the construction industry, it is common for parties to agree to unpriced change
orders that specify the scope of work but not the consideration for that work. The amount of consideration may not be
determined for a period of time. In BC39 of ASU 2014-09, the FASB clarified that it did not intend to preclude revenue
recognition for unpriced change orders if the scope of the work has been approved and the entity expects that the
price will be approved. In those cases, an entity considers the guidance on contract modifications (see Section 7.3) to
determine the appropriate accounting for such change orders. Under the contract modification guidance, if
enforceable rights and obligations are created by the approval of the parties to the change in scope but not the price,
then the change in price is considered variable consideration. See Section 4.3 for discussion on variable consideration.
2.2.2.4 The Contract Has Commercial Substance
FASB REFERENCES
ASC 606-10-25-1(d)
For a contract to be enforceable, it must have commercial substance. That is, the risk, timing or amount of the
entity’s future cash flows is expected to change because of the contract. This criterion was included because without
commercial substance it is questionable whether an entity has entered a transaction that has economic consequences.
Commercial substance is based on the guidance for nonmonetary exchange transactions in ASC 845.
This criterion was developed when the FASB was considering whether an entity should recognize revenue from
contracts with customers that include nonmonetary exchanges. To prevent scenarios where entities might transfer
goods or services back and forth to each other (often for little or no cash consideration) to artificially inflate their
revenues, the FASB decided that an entity cannot recognize revenue from a nonmonetary exchange if the exchange has
no commercial substance. That decision was extended to all contracts (not only nonmonetary exchanges) to prevent an
entity from recognizing revenue for transactions that do not have commercial substance or economic consequences for
the entity. This criterion prevents an entity from recognizing revenue for a contract with customer that serves no
substantive business purpose for the entity.
REVENUE RECOGNITION UNDER ASC 606 29
2.2.2.5 Collectibility
FASB REFERENCES
ASC 606-10-25-1(e) and ASC 606-10-55-3A
For a contract to be enforceable, it must be probable that the entity will collect substantially all of the consideration
to which it will be entitled in exchange for the goods or services that will be transferred to the customer. “Probable”
and “substantially all” are key thresholds in evaluating this criterion and are discussed further in the diagram below.
The consideration to which the entity will be entitled may be less than the price stated in the contract if the
consideration is variable because the entity intends to provide a price concession to the customer. See Section 4.3 for
discussion on variable consideration.
The objective of this assessment is to determine whether the contract is valid and represents a substantive transaction
between the entity and the customer, which is a necessary condition for the contract to be accounted for under the
revenue recognition model in ASC 606.
The following diagram illustrates the key concepts inherent in assessing the collectibility criterion:
In assessing the collectibility criterion, the focus is often on the price included in the contract between an entity and
its customer. However, it is possible that the amount of consideration that the entity ultimately expects to be entitled
to will be less because the entity expects to offer a price concession (or discount) to the customer, regardless of
whether the entity has communicated that to the customer. In that case, the assessment of the customer’s ability and
intention to pay is made based on the lower amount. See Section 4.3 for discussion of variable consideration, including
implicit price concessions.
BC12 of ASU 2016-12 states that if it is not probable that the customer will fulfill its obligations under the contract
(that is, make payments as due), there is a question about whether the contract is valid and the revenue-generating
transaction is substantive, regardless of whether a legal contract exists. However, BC44 of ASU 2014-09 clarifies that
the FASB did not expect many arrangements to fail to meet the collectibility criterion because entities generally only
Probable
ASC 606 defines “probable” as “the future event or
events are likely to occur,” which is consistent with
other U.S. GAAP.
Price Concession
The amount of consideration to which the entity will be entitled may be less than the price stated in the
contract if the entity may offer the customer a price concession.
Substantially All
“Substantially all” is not defined in ASC 606. It is
generally understood as approximately 90% in other
U.S. GAAP (for example, ASC 842). However, ASC 606
does not specify a bright line percentage and
significant judgment may be required to determine
an appropriate threshold.
Goods or Services That Will Be Transferred to The
Customer
An entity assesses the collectibility of the
consideration promised in a contract for “the goods
or services that will be transferred to the customer”
rather than assessing the collectibility of the
consideration promised in the contract for all of the
promised goods or services. That is, the collectibility
assessment is based on a portion of the consideration
promised in the contract—the portion to which the
entity will be entitled in exchange for the goods or
services that will be transferred to the customer.
Collectibility Criterion
REVENUE RECOGNITION UNDER ASC 606 30
enter contracts after concluding it is probable that they will be fairly compensated for their performance. That is, in
most instances, an entity would not enter a contract with a customer if there was significant credit risk from that
customer without also having adequate economic protection to collect the consideration.
2.2.2.5.1 Evaluating Whether Collectibility is Probable
FASB REFERENCES
ASC 606-10-55-3A through 55-3C and ASC 606-10-55-99 through 55-105
In evaluating whether collectibility is probable, an entity evaluates the customer’s financial ability and intention to
pay a consideration when due. The collectibility assessment is partly a forward-looking assessment. It requires an
entity to use judgment and consider all facts and circumstances, including the entity’s customary business practices
and its knowledge of the customer.
Additionally, as part of the collectibility assessment, an entity considers its exposure to credit risk and its ability to
mitigate that credit risk. In assessing collectibility, an entity determines whether the contractual terms and its
customary business practices indicate that the entity’s exposure to credit risk is less than the consideration promised in
the contract because the entity can mitigate its credit risk. Examples of contractual terms or customary business
practices that might mitigate the entity’s credit risk include:
Advance payments: An entity may mitigate all or a portion of its credit risk by requiring advance payments from its
customer where a customer must pay all or a portion of the consideration promised in the contract before the entity
transfers promised goods or services to the customer. The advance payments collected from the customer would not
be subject to credit risk.
Ability to stop transferring goods or services to customers in default: An entity may limit its exposure to credit
risk if it has the right to stop transferring additional goods or services to a customer if the customer fails to pay
consideration when it is due. If the customer fails to perform as promised (that is, pay consideration when due) and
consequently, the entity stops transferring additional goods or services to the customer, the entity will not consider
the likelihood of payment for the promised goods or services that will not be transferred under the contract.
• For example, an entity may have the ability and intent (evidenced by its customary business practice) to
discontinue transfer of services in the third month of a 12-month contract if the customer does not pay as
promised for any of the first three months of services. In this example, the entity evaluates whether the
customer has the intent and ability to pay substantially all of the consideration for the first three months of
services only, because the entity can manage its credit risk for the subsequent nine months by discontinuing the
transfer of additional services to the customer if the customer defaults on payment for the first three months of
services.
An entity’s ability to repossess an asset transferred to a customer is not considered when assessing the entity’s ability
to mitigate its exposure to credit risk because the ability to repossess an asset does not mitigate an entity’s exposure
to its customer’s credit risk for the consideration promised in the contract. An entity’s ability to repossess an asset
transferred to a customer might, however, affect its assessment of when or whether control of the asset transfers to
the customer in some arrangements. See Section 6.6 for discussion on repurchase rights.
2.2.2.5.2 “Substantially All”
The “substantially all” threshold in the collectibility criterion clarifies that a contract may represent a substantive
transaction even if it is not probable the entity will collect 100% of the consideration to which it expects to be
entitled. ASC 606 does not quantify the “substantially all” threshold, which is generally understood as approximately
90% in other U.S. GAAP (for example, ASC 842). However, ASC 606 does not specify a bright line percentage.
REVENUE RECOGNITION UNDER ASC 606 31
BDO INSIGHTS — “SUBSTANTIALLY ALL” THRESHOLD
We believe that interpreting “substantially all” requires the application of professional judgment, based on the
facts and circumstances because ASC 606 does not specify a bright line percentage. Additionally, we believe that
the term must be interpreted consistently in each place it is used in U.S. GAAP.
2.2.2.5.3 “Goods or Services That Will Be Transferred to the Customer”
The phrase “goods or services that will be transferred to the customer” exists only for the purposes of evaluating the
probability of whether an entity will collect substantially all of the consideration to which it will be entitled as part of
identifying the contract with the customer in Step 1. An entity considers whether a valid contract with a customer
exists for the purposes of applying the revenue recognition model in ASC 606 by considering the entity’s exposure to
nonpayment for goods or services that the entity’s rights, obligations, and business practices suggest that the entity
will transfer to the customer.
An entity cannot apply the notion of “goods or services that will be transferred to the customer” to the other aspects
of ASC 606, such as identifying the performance obligations, determining the transaction price, allocating the
transaction price to performance obligations, or recognizing revenue. That is, once a contract is determined to exist
under ASC 606, the rest of the guidance in ASC 606 is applied to the contract.
BDO INSIGHTS — COLLECTIBILITY ASSESSMENT IN STEP 1
Under ASC 606, collectibility is assessed when determining whether a contract exists (in Step 1) rather than when
determining how much revenue to recognize. The collectibility assessment acts as a gating question to determine
whether the five-step revenue recognition model can be applied to a contract. Thus, the collectibility assessment
under ASC 606 precludes revenue recognition when collectibility is not probable; it does not affect the
measurement of revenue recognized. The collectibility assessment requires the application of professional
judgement, based on the facts and circumstances.
EXAMPLE 2-4 (ADAPTED FROM ASC 606-10-55-99 THROUGH 55-101): IMPLICIT PRICE CONCESSION —
CONSIDERATION IS NOT THE STATED FIXED PRICE
An entity sells a product to a customer in return for a contractually agreed amount of $1 million. This is the entity’s
first sale to a customer in a new geographic region and the region is experiencing significant economic difficulty.
Therefore, the entity expects that it will not collect the full contract price. However, even though it may not
collect the full amount, the entity believes that economic conditions in the region will improve in future and
establishing a trading relationship with this customer could help it to open a new market with other potential
customers in the region.
Based on the evaluation of economic difficulties in the region and the entity’s desire to continue the contract with
the customer to generate future revenue growth in that region, the entity determines that it expects to provide a
price concession to the customer and will accept an amount lower than $1 million from the customer. Accordingly,
the entity concludes that the contract price is not fixed at $1 million but rather the consideration in the contract is
variable. The entity estimates the variable consideration it expects to be entitled to is $400,000 (see Section 4.3 for
discussion on variable consideration).
The entity assesses the customer’s intention and ability to pay $400,000 and concludes that despite the poor
economic conditions, it is probable that it will collect $400,000 from the customer. Therefore, the collectibility
criterion is met.
Assuming that the other four contract existence criteria are met, the entity concludes that it has entered a contract
with the customer for the sale of the product in return for a variable consideration of $400,000, which will be
accounted for under the five-step revenue recognition model in ASC 606.
REVENUE RECOGNITION UNDER ASC 606 32
EXAMPLE 2-5 (ADAPTED FROM ASC 606-10-55-102 THROUGH 55-105): IMPLICIT PRICE CONCESSION AND
REASSESSMENT OF CONTRACT EXISTENCE CRITERIA — MEDICAL SERVICES TO UNINSURED PATIENT
A hospital provides certain medical services to an uninsured patient in the emergency room. The hospital has not
previously provided services to that patient. Local law requires the hospital to provide medical services to all
emergency room patients. Given the medical condition of the patient upon arrival, the hospital provided medical
services immediately before determining whether the patient is committed to perform his or her obligations under
the contract in exchange for the medical services provided (that is, pay his or her medical bill). Therefore, the
contract existence criteria are not met, and the hospital will continue to assess its conclusion based on updated
facts and circumstances. See Section 2.5 for discussion on the requirement to continuously reassess contract
existence criteria.
After providing services, to assess the patient’s ability and intention to pay for the services provided, the hospital
reviews the information available about the patient and services provided. It determines that:
Its standard rate for the services provided in the emergency room is $10,000
According to its internal policies and the patient’s income level, the services provided are not charity care
The patient does not qualify for governmental subsidies
Before reassessing whether the contract existence criteria have been met, the hospital considers that although the
standard rate for its services is $10,000 (which is the amount invoiced to the patient), the hospital expects to
accept a lower amount. Accordingly, the hospital concludes that the transaction price is lower than $10,000 and,
therefore, the consideration is variable. Upon reviewing its historical cash collections from this customer class and
other relevant information about the patient, the hospital estimates the variable consideration and determines that
it expects to be entitled to $1,000 (see Section 4.3 for discussion on variable consideration).
In reassessing whether the collectibility criterion has been met, the hospital assesses the patient’s ability and
intention to pay $1,000. Based on its collection history from patients in this customer class, the hospital concludes
it is probable that the hospital will collect $1,000 (that is, the estimated variable consideration). Therefore, the
collectibility criterion is met.
Assuming that the other four contract existence criteria are met, the hospital concludes that it has entered a
contract with the patient for provision of emergency room services in return for a variable consideration of $1,000,
which will be accounted for under the five-step revenue recognition model.
BDO INSIGHTS — IMPLICIT PRICE CONCESSION – VARIABLE CONSIDERATION VERSUS BAD DEBT EXPENSE
Determining whether an entity will give an implicit price concession to the customer by accepting a price lower
than the price stated in the contract is a matter of significant professional judgment, based on the facts and
circumstances. Conceptually, an entity’s decision to accept a lower price represents a concession, whereas a
customer’s default because of the customer’s lack of ability and intent to pay reflects credit risk. Concessions are
presented as a reduction of revenue whereas expectations about amounts to be collected (or defaults) due to credit
risk are relevant in determining the impairment of receivables under ASC 326 and thus the measurement of bad
debt expense.
An entity may have experience indicating that it will not collect all consideration from some customers in a portfolio of
contracts. However, each of the contracts in the portfolio may individually meet the collectibility criterion in Step 1
because it is probable that the customers will pay substantially all of the amounts owed based on credit checks and
other procedures performed by the entity. For example, an entity may have a large volume of homogenous revenue-
generating customer contracts for which the entity’s historical evidence indicates that a small portion of the amounts
billed will become uncollectible. However, in applying the collectibility assessment criterion at the individual contract
level, the entity may determine that it is probable that each of the customers will pay substantially all of the amounts
owed under the relevant contracts. Questions arose in practice as to how an entity should apply Step 1 to contracts in
REVENUE RECOGNITION UNDER ASC 606 33
which the entity has historical experience that it will not collect consideration from some customers in a portfolio of
contracts. The TRG discussed this scenario at its January 2015 meeting as illustrated in the following example:
EXAMPLE 2-6: ASSESSING COLLECTIBILITY FOR A PORTFOLIO OF CONTRACTS
An entity has a large volume of homogenous revenue generating customer contracts for which invoices are sent in
arrears on a monthly basis. Before accepting a customer, the entity performs procedures designed to make sure
that it is probable that the customer will pay the amounts owed. If these procedures result in the entity concluding
that it is not probable the customer will pay the amounts owed, the entity does not accept them as a customer.
Because these procedures are only designed to determine whether collection is probable (and thus not a certainty),
the entity anticipates that some customers will not pay all amounts owed. While the entity collects the entire
amount due from the vast majority of its customers, on average, the entity’s historical evidence (which is
representative of its expectations for the future) indicates that the entity will only collect 97% of the amounts
billed.
The entity bills $100 to its customers in a particular month and there are no other issues that would preclude
recognition of revenue for that amount in the month it is billed. Assume that the performance obligation related to
the billing is satisfied as of the billing date.
The TRG considered whether the entity recognizes (a) revenue of $100 and a bad debt of $3 or (b) revenue of $97
because the historical evidence indicates that it will collect only 97% of the amount billed. The TRG concluded that
the entity recognizes $100 (not $97) as revenue because each contract within the portfolio meets the collectibility
criterion that collection of substantially all of the consideration due under that contract is probable. The entity
applies the subsequent steps in the five-step revenue recognition model to the entire contract rather than the
portion of the contract expected to be collected on a portfolio basis (that is, only 97%). The fact that only 97% of
the amounts invoiced are expected to be collected is relevant in determining the impairment of receivables under
ASC 326.
2.3 CONTRACT ENFORCEABILITY AND TERMINATION CLAUSES
FASB REFERENCES
ASC 606-10-25-3
Sometimes the term or duration of a contract may be readily determinable. However, in other instances, determining
the contract term may require judgment. For example, some contracts with customers may have a fixed duration but
grant the customer renewal or termination rights, with or without an associated penalty payment. Other contracts may
not have a fixed duration and can be terminated or modified by either party at any time, while other contracts may
automatically renew periodically as specified in the contract. An entity applies ASC 606 to the term of the contract in
which the parties to the contract have enforceable rights and obligations.
2.3.1 Wholly Unperformed Contract
FASB REFERENCES
ASC 606-10-25-4
If each party to the contract has the unilateral enforceable right to terminate a wholly unperformed contract without
compensating the other party, then a contract does not exist under ASC 606. A contract is “wholly unperformed” if
both of the following criteria are met:
REVENUE RECOGNITION UNDER ASC 606 34
The entity has not yet transferred any promised goods or services to the customer
The entity has not yet received, and is not yet entitled to receive, any consideration in exchange for promised
goods or services
ASC 606 does not explicitly explain how termination penalties are considered in determining the contractual period in
which the parties have present enforceable rights and obligations. At the January 2015 meeting, the TRG discussed
how termination provisions affect the duration of a contract. See Section 2.3.2 for more discussion.
2.3.2 Effect of a Termination Penalty on Contract Term
A contract exists if each party to the contract has the unilateral enforceable right to terminate the contract only by
paying a substantive termination penalty to the other party. A contract continues to exist during the specified
contractual period regardless of each party’s unilateral and enforceable right to terminate the contract at any time
during the specified contractual period because enforceable rights and obligations exist throughout the contractual
period, which is evidenced by the fact that compensation (a termination penalty) would be required to terminate the
contract. In other words, on termination, the parties to the contract waive their enforceable rights and avoid their
obligations by paying the termination penalty.
BDO INSIGHTS — EFFECT OF TERMINATION PROVISIONS ON ENFORCEABLE RIGHTS AND OBLIGATIONS
The revenue recognition model is applied to the period for which enforceable rights and obligations exist between
an entity and its customer. An entity is required to carefully evaluate substantive termination provisions
(termination rights, termination penalties or other payments) in a contract with a customer and customary business
practices to determine whether the duration for which enforceable rights and obligations exist is shorter or longer
than the contractually stated term.
BDO INSIGHTS — ANALYZING TERMINATION PENALTIES
ASC 606 does not define penalty or termination penalty. Additionally, ASC 606 does not contain bright lines for
determining whether a termination penalty is substantive. In analyzing whether either party must “compensat[e]
the other party” to exercise a termination right, an entity evaluates any amount payable upon termination that is
unrelated to the payments due for the goods or services transferred up to the termination date. Therefore, the
analysis is not restricted only to payments explicitly characterized as termination penalties. Rather, the substance
of the payments made to compensate the other party to terminate a contract prior to the stated term is
considered.
Additionally, the analysis of termination penalties is not restricted only to cash payments. For example, in certain
R&D arrangements, requiring the customer to return an exclusive license to a drug compound upon early
termination of the contract may represent a substantive termination penalty. Conversely, requiring the customer to
return a nonexclusive software license upon early termination of the software license contract may not represent a
substantive termination penalty.
Determining what constitutes a termination penalty and whether the termination penalty is substantive requires the
application of professional judgment, based on the facts and circumstances.
EXAMPLE 2-7: MONTHLY TERMINATION RIGHTS IN AN ANNUAL CONTRACT — TERMINATION RIGHTS ARE HELD BY
BOTH PARTIES
An entity enters a contract with a customer to provide cleaning services. The stated contract term is one year. The
contract is cancelable at the end of each month by either party without penalty.
REVENUE RECOGNITION UNDER ASC 606 35
The enforceable rights and obligations for the parties to the contract do not extend beyond the then-current month
because either party can terminate the contract without penalty at the end of each month. The entity accounts for
the contract as a month-to-month contract.
The term of a contract in which each party has the unilateral enforceable right to terminate the contract without
penalty does not extend beyond the then-current period. However, if only one party could terminate a contract
without penalty, some enforceable rights and obligations may exist even if the term of the contract is limited to the
then-current period. For example, if only the customer could terminate a contract without penalty, the entity is
obliged to stand ready to perform at the discretion of the customer. The customer, in effect, can extend the contract
by not exercising its termination rights, which might represent a material right. See Chapter 3 and Section 7.4 for
discussion on customer options and material rights.
EXAMPLE 2-8: MONTHLY RENEWAL RIGHTS IN AN EVERGREEN (MONTH-TO-MONTH) CONTRACT — RENEWAL
RIGHT IS HELD BY THE CUSTOMER
An entity enters a contract with a customer to provide cleaning services. The stated contract term is one month,
and the contract automatically renews at the end of each month unless the customer elects not to renew.
When only the customer has a unilateral option to renew the contract for another month (by electing not to
terminate the contract at the end of a month), enforceable rights and obligations exist only for the then-current
month.
Additionally, the customer has an enforceable right to receive, and the entity is obligated to provide, cleaning
services in the subsequent months if the customer chooses to renew the contract by not exercising its termination
rights. The unilateral renewal rights held by the customer effectively provide the customer 11 renewal option(s) to
extend the contract.
The entity evaluates whether the customer’s renewal options are accounted for as material rights, which are
separate performance obligations under Step 2. See Chapter 3 and Section 7.4 for discussion on performance
obligations, customer options and material rights.
If the contract does not include a material right, then the entity disregards the customer’s options (termination
rights) and applies the five-step revenue recognition model to the first month only.
If the contract includes a material right, then the entity allocates a portion of the consideration received from the
customer to the material right and defers recognizing it in revenue until the customer exercises the option or the
option lapses.
The existence of a material right does not extend the contract term beyond the then-current month; that is, the
contract term remains one month. However, the existence of a material right affects the amount and timing of
revenue recognition for a contract because consideration allocated to the material right is deferred for a later
recognition in revenue. See Section 7.4 for discussion on accounting for material rights, including the accounting
policy election to account for a customer’s exercise of a material right as the continuation of a contract or a
contract modification.
EXAMPLE 2-9: MONTHLY TERMINATION RIGHTS IN AN ANNUAL CONTRACT — TERMINATION RIGHT IS HELD BY THE
CUSTOMER
An entity enters a contract with a customer to provide cleaning services. The stated contract term is one year. The
customer has a unilateral right to terminate the contract at the end of each month without penalty.
When only the customer has a unilateral option to terminate a period-to-period contract, enforceable rights and
obligations exist only for the then-current month. Additionally, the customer has an enforceable right to receive,
and the entity is obligated to provide, cleaning services in the subsequent months if the customer chooses to not
REVENUE RECOGNITION UNDER ASC 606 36
exercise its termination right. The unilateral termination right held by the customer effectively provides the
customer 11 renewal option(s) to extend the contract by not exercising its termination rights. The entity evaluates
whether the customer’s options are accounted for as material rights, as discussed in Example 2-8.
TRG DISCUSSIONS — CONTRACT ENFORCEABILITY AND TERMINATION CLAUSES
Although ASC 606 contains guidance on when a contract exists, questions were raised about how to assess whether a
contract exists for accounting purposes (and, if so, the contract duration) if the contract between an entity and its
customer contains termination clauses. The TRG considered the following examples in deliberating how such clauses
must be considered by an entity and generally agreed with the following conclusions:
Example A
An entity enters a contract with a customer to provide services until the contract is terminated. Each party can
terminate the contract without compensating the other party for the termination (that is, there is no termination
penalty).
The duration of the contract does not extend beyond the services already provided.
Example B
An entity enters a contract with a customer to provide services for two years. Each party can terminate the
contract at any time after 15 months from the start of the contract without compensating the other party for the
termination.
The duration of the contract is 15 months.
Example C
An entity enters a contract with a customer to provide services for two years. Either party can terminate the
contract by compensating the other party.
The duration of the contract is the specified contractual period of two years.
Example D
An entity enters a contract with a customer to provide services for 24 months. Either party can terminate the
contract by compensating the other party. The entity has a past practice of allowing customers to terminate the
contract at the end of 12 months without enforcing collection of the termination penalty.
In this case, whether the contractual period is 24 months or 12 months depends on whether the past practice is
considered by law to restrict the parties’ enforceable rights and obligations, which may vary by jurisdiction. The
entity’s past practice of allowing customers to terminate the contract at the end of month 12 without enforcing
collection of the termination penalty affects the contract term only if that practice changes the parties’ legally
enforceable rights and obligations. If that past practice does not change the parties’ legally enforceable rights and
obligations, then the contract term is the stated period of 24 months.
REVENUE RECOGNITION UNDER ASC 606 37
BDO INSIGHTS — SIGNIFICANCE OF THE CONTRACT TERM
An entity needs to first determine the duration of the contract (or contract term) to apply certain aspects of the
five-step revenue recognition model (for example, identifying performance obligations, determining the transaction
price, and recognizing revenue upon satisfaction of a performance obligation). The contract term is also important
when determining whether a practical expedient can be elected. For example, an entity can elect the practical
expedient on significant financing components in Step 3 for a short contract term (one year or less).
Determining the contract term is generally not complex when a contract has a stated duration and neither party has
the unilateral right to cancel the contract. Additionally, it may not be particularly relevant to revenue recognition
if the only promises are goods that are delivered at a point in time. However, it can be more challenging to
determine the contract term when either party has cancellation rights. Analyzing cancellation rights to determine
the contract term may require the application of professional judgment, based on the facts and circumstances. In
some cases, legal advice may be required to determine the duration for which enforceable rights and obligations
exist.
REVENUE RECOGNITION UNDER ASC 606 38
2.4 CONTRACT EXISTENCE CRITERIA ARE NOT MET
FASB REFERENCES
ASC 606-10-25-6 through 25-8
The following diagram provides an overview of the accounting requirements when the contract existence criteria are
not met:
If any of the five contract existence criteria are not met, a contract does not exist for revenue recognition purposes
regardless of whether a legal contract exists. ASC 606 includes the following guidance, which is applied when an
arrangement with a customer does not meet the contract existence criteria:
Continuous reassessment of whether the contract existence criteria are subsequently met
Accounting for consideration received from customer before contract existence criteria are met
2.4.1 Continuous Reassessment of Contract Existence Criteria
FASB REFERENCES
ASC 606-10-25-6
An entity continuously reassesses arrangements with customers that do not meet all of the five contract existence
criteria to determine whether and when those criteria are subsequently met. An entity applies the five-step revenue
recognition model when the contract existence criteria are met.
* Continuously reassess the contract
to determine whether the contract existence criteria in ASC 606-10-25-1 are
subsequently met
Does a contract
with a customer
exist?
Has the entity
received
consideration
from customer?
No accounting
impact
No*
No
Are contract
existence criteria
in ASC 606-10-25-1
subsequently met?
Yes
Apply the five-
step revenue
recognition model
to the contract
Yes
No
Have one of the
events in
ASC 606-10-25-7
occurred?
Yes
Recognize revenue
(ASC 606-10-25-7)
Recognize a
liability
(ASC 606-10-25-8)
No
REVENUE RECOGNITION UNDER ASC 606 39
2.4.2 Consideration Received From Customer Before Contract Existence Criteria Are Met
FASB REFERENCES
ASC 606-10-25-7 and 25-8
If the contract existence criteria are not met and an entity receives consideration from the customer, the amount
received is recognized as revenue only when any one of the three following events (specified in ASC 606-10-25-7) has
occurred:
The entity has no remaining contractual obligations to transfer goods or services and all, or substantially all, of the
consideration has been received and is nonrefundable
The contract has been terminated and the consideration received is nonrefundable
The entity has transferred control of the goods or services to which the consideration that has been received
relates, the entity has stopped transferring goods or services to the customer (if applicable) and has no obligation
under the contract to transfer additional goods or services, and the consideration received from the customer is
nonrefundable
An entity cannot recognize revenue until the contract is complete or cancelled or until a subsequent reassessment
indicates that the contract meets all contract existence criteria. Any consideration received from the customer is
recognized as a liability until either the criteria for a contract to exist are subsequently met, or one of the three
events in ASC 606-10-25-7 occurs. Depending on the specifics of the contract, the liability recognized represents the
entity’s obligation to transfer goods or services or to refund the consideration received. In either case, the liability is
measured as the amount received from the customer.
The guidance on accounting for consideration received from a customer when the contract existence criteria are not
met avoids revenue recognition related to contracts that may not be valid and that do not represent genuine
transactions; recognizing revenue for those contracts would not provide a faithful representation of an entity’s
business activities.
NONREFUNDABLE PAYMENTS RECEIVED FROM A CUSTOMER BEFORE THE CONTRACT EXISTENCE CRITERIA
ARE MET
Regardless of whether the consideration received from the customer is nonrefundable, an entity cannot recognize
revenue based on cash collected from the customer unless either the contract existence criteria are subsequently
met (in which case the entity follows Steps 2 through 5 for recognizing revenue) or one of the three events in
ASC 606-10-25-7 has occurred.
2.5 REASSESSMENT OF CONTRACT EXISTENCE CRITERIA
FASB REFERENCES
ASC 606-10-25-5 and ASC 606-10-55-106 through 55-109
If a contract with a customer meets the contract existence criteria at contract inception, an entity does not reassess
those criteria unless there is an indication of a significant change in facts and circumstances. The standard includes an
REVENUE RECOGNITION UNDER ASC 606 40
example, which states that if a customer’s ability to pay the consideration deteriorates significantly, an entity must
reassess whether it is probable that the entity will collect the consideration to which the entity will be entitled in
exchange for the remaining goods or services that will be transferred to the customer.
When an entity determines that a previously identified contract no longer meets the contract existence criteria:
No further revenue is recognized until either the entity can once again conclude that the contract existence criteria
(including the collectibility criterion) are met or the revenue recognition requirements in ASC 606-10-25-7 are met
(see Section 2.4.2 for discussion of the accounting for consideration received from customer when contract
existence criteria are not met).
Any revenue, receivable or contract asset recognized to date is not reversed. Instead, the receivable or contract
asset is subject to the impairment guidance in ASC 326.
EXAMPLE 2-10 (ADAPTED FROM ASC 606-10-55-106 THROUGH 55-109): REASSESSING THE CRITERIA FOR
CONTRACT EXISTENCE
An entity and a customer enter a multi-year contract for the transfer of certain goods or services. The contract
meets the contract existence criteria at the inception of the multi-year contract and, therefore, the entity starts
recognizing revenue from the contract according to the five-step revenue recognition model.
In the second year of the contract the customer’s financial condition declines and its access to credit and available
cash on hand are limited. The entity continues to recognize revenue in the second year and evaluates any
receivables recognized for impairment.
At the beginning of the third year of the contract, the entity becomes aware that the customer has lost access to
credit and its major customers, and thus the customer’s ability to pay significantly deteriorates. The entity
determines that it is unlikely that the customer will be able to make any further payments for goods or services
being transferred.
Because of this significant change in facts and circumstances, the entity reevaluates the contract existence criteria
and concludes that the contract existence criteria are no longer met because collectibility is no longer probable.
Based on that conclusion, the entity does not recognize revenue for that customer in the third year.
The entity does not reverse any revenue or existing receivables recognized during the first and second years of the
contract. The entity accounts for the impairment of any existing receivables under ASC 326.
BDO INSIGHTS — REASSESSMENT OF CONTRACT EXISTENCE CRITERIA
Determining whether there is a significant change in facts or circumstances requiring a reassessment of contract
existence criteria requires the application of professional judgment, based on the facts and circumstances. The
facts in Example 2-10 on reassessing the existence of a contract include a severe deterioration in the customer’s
financial condition to demonstrate that the standard does not intend to capture minor changes in facts and
circumstances (that is, those that do not call into question the validity of the contract), which might reasonably
fluctuate during a contract term, especially a long-term contract.
REVENUE RECOGNITION UNDER ASC 606 41
2.6 COMBINATION OF CONTRACTS
FASB REFERENCES
ASC 606-10-25-9
Two or more contracts entered at or near the same time and with the same customer (or related parties of the
customer, as defined in ASC 850, Related Party Disclosures) are accounted for as if they were a single contract, if one
of the following criteria are met:
The guidance requiring the combination of two or more contracts was provided because in some cases, the amount and
timing of revenue might differ depending on whether an entity accounts for two or more contracts separately or as one
contract. A necessary condition for two or more contracts to be combined is that they must be executed at or near the
same time with the same customer (or the customer’s related parties).
Multiple contracts negotiated at or near the same time with the same customer or its related parties with a single
commercial objective or by pricing one contract based on the price or performance of other contract(s) create pricing
interdependencies between the separate contracts. Those contracts are required to be combined so that the combined
consideration is allocated to the performance obligations in the combined contract, resulting in revenue recognition
that faithfully depicts the value of the performance obligations transferred to the customer.
Some or all the promised goods or services in separate contracts negotiated at or near the same time with the same
customer or its related parties may comprise a single performance obligation. Those contracts are required to be
combined to preclude an entity from effectively bypassing the guidance for identifying performance obligations based
on how contracts are legally structured. Rather, the contracts are combined and revenue for the single performance
obligation is recognized when or as it is satisfied. See Chapters 3-6 for discussion on Steps 2 through 5 on identifying
performance obligations, determining the transaction price, allocating the transaction price, and recognizing revenue.
BDO INSIGHTS — COMBINING CONTRACTS REQUIRES JUDGMENT
Determining whether multiple contracts entered with the same customer (or its related parties) at or near the same
time must be combined requires the application of professional judgment, based on the facts and circumstances. An
entity considers the facts and circumstances surrounding those contracts, the pricing and the nature of the goods or
services being transferred to evaluate the substance of those contracts and determine whether they must be
combined.
Additionally, the phrase “at or near the same time” is not defined under ASC 606. Entities may establish accounting
policies to define that term (for example, as 90 days). However, the standard does not include a bright line.
Therefore, determining whether any contracts executed shortly outside the defined time frame are within the
scope of contract combination guidance requires the application of professional judgment, based on the facts and
circumstances.
* See
Chapter 3 for discussion on performance obligations.
The contracts are
negotiated as a package
with a single
commercial objective.
The amount of
consideration in one
contract depends on the
price or performance of
the other contract(s).
The goods or services
that are promised in the
contracts (or some of
the goods or services)
represent a single
performance
obligation.*
REVENUE RECOGNITION UNDER ASC 606 42
BDO INSIGHTS — CONTRACT COMBINATION GUIDANCE – CUSTOMER’S RELATED PARTIES
The standard requires an entity to consider whether the contract combination guidance is applicable to contracts
that are entered with two or more separate parties who are related parties, because there may be
interdependencies between or among those contracts. The amount and timing of revenue recognized might differ
depending on whether those contracts are accounted for as separate contracts as opposed to a single contract. The
term “related parties” has the same meaning as the definition in ASC 850, which encompasses a wide range of
entities and individuals, and careful analysis may be required to ensure that all of these parties are considered.
Determining whether another entity is a related party of the customer and whether multiple contracts entered with
the customer and the customer’s related party must be combined requires the application of professional
judgment, depending on the facts and circumstances.
SEC STAFF GUIDANCE
Remarks before the 2016 Baruch College Financial Reporting Conference
Wesley R. Bricker, Deputy Chief Accountant, Office of the Chief Accountant
May 5, 2016
Contract Combination Guidance – Limited to a Customer and Its Related Parties
An SEC staff speech stated that the SEC’s Office of the Chief Accountant was consulted on the
contract combination guidance in ASC 606. The SEC staff objected to extending the contract
combination guidance beyond contracts with the same customer or related parties of the same
customer because ASC 606 explicitly limits which contracts may be combined. Therefore, an
entity cannot combine contracts with different counterparties who are not related parties, even
if they are negotiated as a package with the same commercial objective.
BDO INSIGHTS — CONTRACT COMBINATION GUIDANCE — DIFFERENT DEPARTMENTS OF AN ENTITY
An entity may enter contracts with different departments or divisions of the customer entity. Regardless of whether
the different departments function independently within the entity, those contracts fall within the scope of
contract combination guidance and must be combined if the contract combination requirements are met.
Similarly, when evaluating contracts with different departments of a government body (federal, state, local, or
foreign), different departments under the control of the same government body are generally considered part of a
single entity. For example, separate contracts with different departments of the federal government may be
combined if the contract combination requirements are met.
REVENUE RECOGNITION UNDER ASC 606 43
BDO INSIGHTS — INTERACTION BETWEEN THE GUIDANCE ON CONTRACT COMBINATION AND CONSIDERATION
PAYABLE TO CUSTOMER
When evaluating multiple contracts with a customer or its related parties that require the entity to make cash or
noncash payments to the customer or the customer’s related parties, an entity must carefully consider the
applicability of the guidance on consideration payable to the customer, along with the guidance on contract
combination. Consideration payable to the customer is recognized as a reduction in revenue if certain conditions
are met (see Section 4.6 for related discussion).
For example, consider a biotechnology entity that sells R&D services and a functional IP license to a customer in
exchange for a fee. The biotechnology entity in-licenses certain technology from the customer’s related party in
exchange for a fee and uses that technology to provide the R&D services to the customer. If the two contracts were
entered at or near the same time, the biotechnology entity must evaluate whether the two contracts must be
combined, for example, because they have a single commercial objective or pricing interdependencies. If the
contracts are combined, then the payments made by the biotechnology entity to the customer’s related party for
the in-license may be recognized as a reduction in revenue (rather than as an expense) under the guidance on
consideration payable to customer.
Reaching a conclusion about whether to combine contracts and recognize payments to a customer or its related
parties) as a reduction in revenue requires the application of professional judgment, based on the facts and
circumstances.
REVENUE RECOGNITION UNDER ASC 606 44
CHAPTER 3 — STEP 2: IDENTIFY
THE PERFORMANCE OBLIGATIONS
IN THE CONTRACT
3.1 OVERVIEW
FASB REFERENCES
ASC 606-10-25-14
After identifying the contract for accounting purposes in Step 1, an entity must identify the promised goods and
services within the contract and determine which of those goods and services are separate performance obligations.
A “performance obligation” is the unit of account for applying ASC 606 to recognize revenue from the transfer of
promised goods and services to a customer. In Steps 3 through 5, the transaction price in a contract is allocated to
each performance obligation in the contract, and the allocated transaction price is recognized in revenue when or as
the performance obligation it relates to is satisfied. Correctly identifying the performance obligations in a contract is
fundamental to the principle that the amount and timing of revenue recognized for the contract must faithfully depict
an entity’s performance in transferring the promised goods or services to the customer.
At contract inception, an entity assesses the promised goods and services in a contract and identifies separate
performance obligations. A performance obligation is a promise to transfer to a customer either:
A good or service (or a bundle of goods or services) that is distinct
A series of distinct goods or services that are substantially the same and have the same pattern of transfer to the
customer
Presentation
and
Disclosures
Scope
Step 1:
Identify the
contract
with a
customer
Step 2:
Identify the
performance
obligations in
the contract
Step 3:
Determine
the
transaction
price
Step 4:
Allocate the
transaction price to
the performance
obligations
Step 5:
Recognize revenue
when or as the
performance
obligation is
satisfied
Other
Topics
REVENUE RECOGNITION UNDER ASC 606 45
BDO INSIGHTS — A PERFORMANCE OBLIGATION IS THE UNIT OF ACCOUNT FOR REVENUE RECOGNITION
Appropriate identification of the performance obligations in a contract is crucial because each performance
obligation is a separate “unit of account” for determining when and how much revenue to recognize.
Additionally, the accounting for contract modifications (see Section 7.3) is based on, among other things, whether a
promised good or service is distinct (and therefore a performance obligation) and whether a performance obligation
in a contract has been satisfied before the modification date. Therefore, even if a contract includes multiple
performance obligations that are satisfied concurrently and could practically be accounted for as a single
performance obligation, an entity is required to correctly identify performance obligations in the original contract if
that contract is modified.
BDO INSIGHTS — REASSESSING PERFORMANCE OBLIGATIONS
The performance obligations identified in a contract are not reassessed unless the contract is modified, and the
modification is not accounted for separately from the existing contract. See Section 7.3 for discussion on accounting
for contract modifications.
ASC 606 also includes specific guidance for determining whether a warranty is a performance obligation and a practical
expedient for franchisors that are nonpublic entities (nonpublic franchisors) when identifying performance obligations.
The following diagram provides an overview of Step 2:
REVENUE RECOGNITION UNDER ASC 606 46
Exclude immaterial promises.
Promised goods or
services are
distinct.
Identify promised
goods or services.
Are the promised
goods or services
“distinct”?
Promised goods or
services are not
distinct and are
grouped with
other promised
goods or services
that are together
distinct.
Are the promised goods or
services distinct within the
context of the contract?
Fulfillment activities are not
promised goods or services.
The series of
distinct goods or
services is
considered one
performance
obligation.
Is the series guidance
applicable?
Series guidance is
not applicable.
the distinct goods
or services are
separate
performance
obligations.
Are the distinct goods or
services substantially the same?
Do the distinct goods or
services have the same pattern
of transfer to the customer?
No
Yes
Yes
Yes
Are the promised goods or
services capable of being
distinct?
No
No
No
Yes
REVENUE RECOGNITION UNDER ASC 606 47
3.2 PROMISES IN CONTRACTS WITH CUSTOMERS
FASB REFERENCES
ASC 606-10-25-16 through 25-18
To identify the performance obligations in a contract with a customer, an entity is first required to identify, at
contract inception, all of the promised goods or services in that contract. Generally, all goods or services that an entity
promises to transfer to a customer are identified explicitly in the contract. Examples of promised goods or services
include the sale of goods, performing agreed-upon tasks, standing ready to provide goods or services (for example,
unspecified software updates to software provided on when-and-if-available basis), arranging for another party to
transfer goods or services, constructing an asset on behalf of a customer, and granting licenses.
3.2.1 Implied Promises in a Contract
FASB REFERENCES
ASC 606-10-25-16
Promised goods and services in a contract are not limited to the goods or services that are explicitly stated in that
contract. In some cases, promises to provide goods or services might be implied by the entity’s customary business
practices, published policies or specific statements if, at the time of entering the contract, the customer has a
reasonable expectation that it will receive certain goods or services from the entity. If the customer has a reasonable
expectation that it will receive certain goods or services not explicitly identified in the contract, it will likely view
those promises as part of the negotiated exchange.
IMPLIED PROMISES — CONSIDERING CUSTOMER’S EXPECTATIONS
In identifying the implied promises in a contract, it is important for an entity to consider the customer’s
expectations (rather than only the entity’s perspective) regarding which goods or services the customer expects to
receive and for which it has paid or will pay under the contract.
Analyzing customer’s expectations and identifying implied promises requires the application of professional
judgment, based on the facts and circumstances.
While a contract with a customer identified in Step 1 must be enforceable by law, implied promises in the contract do
not need to be enforceable by law. If the customer has a valid expectation that the entity will transfer a good or
service, then the customer would view that promise as a part of the negotiated exchange. In BC87 of ASU 2014-09, the
FASB stated that absent this guidance, an entity might recognize all the consideration in a contract as revenue even
though the entity continues to have remaining implied promises related to the contract with the customer.
REVENUE RECOGNITION UNDER ASC 606 48
3.2.2 Promises That Require the Involvement of a Third Party
FASB REFERENCES
ASC 606-10-25-18
Promised goods and services in a contract may include:
Resale of rights to goods or services purchased by the entity to its customer. For example, a ticket reseller may
purchase tickets from an airline and then sell the tickets (or the right to the flight service) to its customer.
Providing a service of arranging for another party to transfer goods or services to a customer. For example, an
entity may act as an agent of another party who will transfer goods or services to a customer.
In this type of arrangement, another party is involved in providing goods or services to the customer. Therefore, an
entity needs to determine whether it is the principal or agent in that arrangement for revenue recognition purposes.
See Section 7.2 for discussion on principal versus agent considerations.
3.2.3 Promises to a Customer’s Customer
FASB REFERENCES
ASC 606-10-25-18(g)
Granting a right to goods or services to be provided in the future that a customer can transfer to its customer (for
example, when an entity makes a promise to provide goods or services to its customer’s customer) is a promised good
or service in a contract. Those types of promises exist in distribution networks in various industries, for example, the
automotive industry.
For example, when a manufacturer sells a motor vehicle to its customer, a motor vehicle dealer, the manufacturer
may promise to provide additional goods or services, such as maintenance, to the dealer’s customer. An entity is
required to identify all of the promises, both explicit and implicit, that are made to the customer as part of the
contract with that customer. Consequently, the manufacturer’s promise to provide a good or service (such as
maintenance) that the dealer can pass on to the dealer’s customer would be a performance obligation for the
manufacturer if that promise could be identified (explicitly or implicitly) in the manufacturer’s contract with the
dealer.
However, some promised goods or services that do not exist (explicitly or implicitly) at the time the parties agree to
the contract but are added after contract inception do not represent performance obligations in the original contract
but are instead new contracts entered with a different counterparty.
3.2.4 Customer Options to Purchase Additional Goods or Services — Material Right
FASB REFERENCES
ASC 606-10-25-18(j)
Granting an option to a customer to purchase additional goods or services could be a promised good or service in a
contract when that option provides the customer with a material right. See Section 7.4 for discussion on customer
options and material rights.
REVENUE RECOGNITION UNDER ASC 606 49
Additionally, see Section 7.4.1.1 for a summary of the TRG discussions on whether a variable quantity of a good or
service constitutes a customer’s purchase option(s) or variable consideration.
3.2.5 Exception for Immaterial Promises in a Contract
FASB REFERENCES
ASC 606-10-25-16A and 25-16B
An entity is not required to assess whether promised goods or services are performance obligations if they are
immaterial in the context of the contract with the customer (see Section 3.3 for discussion on identifying performance
obligations). That is, an entity is exempt from accounting for performance obligations that an entity might consider
perfunctory or inconsequential. Assessing whether a promised good or service is immaterial at the contract level
requires judgment. BC12 of ASU 2016-10 states that in assessing immateriality, an entity considers both the
quantitative and qualitative nature of the promised goods or services in the contract. An entity also considers the
relative significance or importance of a promised good or service in the contract to the arrangement with the customer
as a whole.
If the revenue related to a performance obligation that includes goods or services that are immaterial in the context of
the contract is recognized before those immaterial goods or services are transferred to the customer, then the related
costs to transfer those goods or services are accrued.
An entity cannot apply the exception for immaterial promises to a customer’s option to acquire additional goods or
services that provides the customer with a material right. See Section 7.4 for discussion on customer options and
material rights.
3.2.6 Fulfillment Activities
FASB REFERENCES
ASC 606-10-25-17
Activities performed to fulfill a contract that do not transfer goods or services to the customer are not considered
promised goods or services in a contract, even though those activities are required to successfully transfer the goods or
services for which the customer has contracted. Fulfillment activities may exist in many contracts in which an entity
undertakes separate activities that do not directly transfer goods or services to the customers. For example, a service
provider may need to perform various administrative tasks (or set up activities) to set up a contract before providing
services to the customer. The performance of the administrative tasks does not transfer a service to the customer as
the tasks are performed and, therefore, those activities are not promised goods or services in the contract.
See Section 7.7 for discussion on accounting for costs incurred to fulfil a contract with a customer.
3.2.6.1 Tooling and Set-Up Activities
Manufacturing entities often incur significant costs at the inception of contracts for tooling, equipment, and
engineering start-up activities, often referred to as “pre-production activities.” Manufacturers need to consider
whether these pre-production activities are a promised good or service, or whether they are fulfillment activities,
which requires judgment and consideration of the facts and circumstances. If a manufacturer has difficulty in
determining whether a pre-production activity is a promised good or service in a contract, it evaluates whether control
of that good or service is transferred to the customer (for example, whether the customer will own the results of the
pre-production activity even if the contract is terminated). If so, this may indicate that the pre-production activity is a
promised good or service.
REVENUE RECOGNITION UNDER ASC 606 50
EXAMPLE 3-1: TOOLING AND SET-UP ACTIVITIES
An entity manufactures parts for the automobile industry and has contracted with a customer to supply pistons.
Each piston is determined to be a distinct performance obligation. To fulfill the contract, the entity must:
Purchase an additional diamond-core cutting machine costing $500,000 and tooling costing $200,000
Incur engineering costs of $100,000 to configure the production line
The entity receives $1,000,000 from the customer at contract inception to compensate for the pre-production
activities.
The entity retains title to the equipment, tooling, and any IP (for example, patents) that result from the
engineering activities. The entity is also responsible for maintaining and directing the use of the tooling and
equipment.
The entity determines that the contract includes the promise to transfer pistons to the customer, and the pre-
production activities do not result in control of additional goods or services being transferred to the customer.
Therefore, the pre-production activities are not promised goods or services and cannot be a separate performance
obligation within the contract.
The entity includes the upfront $1,000,000 payment within the transaction price (see Chapter 4 for discussion on
determining the transaction price) and initially records it as a contract liability (deferred revenue). A portion of the
contract liability is derecognized and credited to revenue as control over each piston is transferred to the customer
(presuming the contract consists of multiple performance obligations, that is, each piston is a separate performance
obligation). See Chapter 6 for discussion on recognizing revenue when (or as) a performance obligation is satisfied.
BDO INSIGHTS — PRE-PRODUCTION ACTIVITIES
If pre-production activities do not represent a separate performance obligation and are related to a performance
obligation for which revenue is recognized over time (instead of a point in time, as is the case in Example 3-1), the
pre-production activities are not considered when measuring progress toward completion of that performance
obligation because they do not result in control of a good or service being passed to the customer. In other words,
the manufacturer does not recognize any revenue just by incurring any of the $800,000 of pre-production activities.
Instead, those costs are treated as costs to fulfill a contract. See Chapter 6 for discussion on recognizing revenue
over time and measure of progress and Section 7.7 for discussion on accounting for the costs of contracts with
customers.
In contrast, if the pre-production activities are determined to be a promised good or service, a portion of the
transaction price is allocated to that good or service, as either a single performance obligation or as part of a
combined performance obligation that includes the pre-production activities with other goods and services.
BDO INSIGHTS — PRE-PRODUCTION ACTIVITIES FOR LONG-TERM SUPPLY CONTRACTS
ASC 340-10, Other Assets and Deferred Costs — Overall, includes guidance on accounting for the costs of designing
and developing “molds, dies, and other tools that will be used in producing” products under a long-term supply
agreement. ASC 606 did not amend or supersede the guidance provided on pre-production costs in ASC 340-10.
Therefore, manufacturers that conclude that their pre-production costs are within the scope of ASC 340-10 continue
to follow that guidance after adopting ASC 606. Additionally, entities apply the guidance in ASC 340-40 to account
for pre-production costs that are not within the scope of ASC 340-10. See Section 7.7 for discussion on accounting
for the costs of contracts with customers.
REVENUE RECOGNITION UNDER ASC 606 51
TRG DISCUSSIONS — PRE-PRODUCTION ACTIVITIES — ANALYZING CONTROL
In November 2015, the TRG discussed an implementation question about whether pre-production activities are a
promised good or service or included in the measure of progress toward complete satisfaction of a performance
obligation that is satisfied over time.
The TRG observed that entities may find it helpful to consider the core principle of ASC 606 “that an entity shall
recognize revenue to depict the transfer of promised goods and services to customers in an amount that reflects
the consideration to which the entity expects to be entitled in exchange for those goods or services.”
Furthermore, ASC 606 specifies that the good or service is transferred when (or as) the customer obtains control.
The FASB staff provided an example to illustrate an entity’s assessment of whether control of a good or service is
transferred to the customer when the entity is having difficulty determining whether pre-production activities are a
promised good or service. An entity is performing engineering and development activities as part of developing a
new product for a customer and the customer will own the IP (for example, patents) that results from those
activities. The entity would likely conclude that it is transferring control of that IP to the customer and
consequently, the engineering and development activities are promised goods or services in the contract.
The FASB staff used this straightforward example to illustrate a case in which it was clear that control transferred
to the customer. However, sometimes an entity needs to apply judgment to determine whether control of a good or
service transfers to the customer. ASC 606 includes criteria for determining whether an entity transfers control of a
good or service over time and, therefore, satisfies a performance obligation over time. The FASB staff thinks that
one of those criteria that may be applicable to pre-production activities is whether the customer simultaneously
receives and consumes the benefits provided by the entity’s performance as the entity performs. Sometimes an
entity may not be able to readily identify whether this criterion is met. In those circumstances, an entity considers
whether another entity would need to reperform the work that the entity has completed to date if that other entity
were to fulfill the remaining performance obligation.
For example, consider a scenario in which an entity is performing engineering and development activities as part of
developing a new product for a customer. If the entity provides the customer with periodic progress reports (in a
level of detail that would not require the customer to contract with another entity to reperform the work) or if the
entity must provide the customer with the design information completed to date in the case of a termination of the
contract, then the entity likely would conclude that control of that service has transferred to the customer.
As another example, when a piece of equipment is transferred over time, an entity has determined that the
customer has control over the asset because, for example, the entity has a right to payment for an asset with no
alternative use. The entity might include labor costs in a cost-to-cost measure of progress for constructing the piece
of equipment. The labor itself is not a separate promised good or service to the customer in the contract. However,
each time the worker turns a wrench, the asset (the equipment) is changed, and the customer obtains control of
that changed asset. Similarly, an entity might determine the pre-production cost should be included in the measure
of progress, depending on the circumstances of the arrangement. However, if the arrangement involves significant
costs for the entity near the start of the arrangement and the activities giving rise to those costs do not transfer a
good or a service to the customer, then the entity considers the guidance on adjustments to the measure of
progress when using a cost-based input method. Application of that guidance requires an entity to consider whether
the costs for certain activities must be excluded from the measure of progress or whether the input method must be
adjusted to recognize revenue only to the extent of that cost incurred.
See Chapter 6 for discussion on the notion of control, recognizing revenue over time or at a point in time, measure
of progress and adjustments to the measure of progress when using a cost-to-cost method.
REVENUE RECOGNITION UNDER ASC 606 52
3.2.6.2 Shipping and Handling Activities
FASB REFERENCES
ASC 606-10-5-18A
An entity that promises to transfer goods to a customer may perform shipping and handling activities related to those
goods. If the shipping and handling activities are performed before the customer obtains control of the goods, the
shipping and handling activities are not promised services to the customer but rather activities to fulfill the entity’s
promise to transfer goods.
3.2.6.2.1 Shipping and Handling Activities — Accounting Policy Election
FASB REFERENCES
ASC 606-10-5-18B
If shipping and handling activities are performed after a customer obtains control of the good, then the entity may
elect to account for shipping and handling as activities to fulfill the promise to transfer the good rather than as
additional promised services.
If an entity opts for the accounting policy election:
Shipping and handling activities are not identified as separate performance obligations and no revenue is allocated
to them.
If revenue for related goods is recognized before the shipping and handling activities occur, an entity must accrue
the related costs of those shipping and handling activities.
If the accounting policy election is not made, then the entity evaluates shipping and handling activities as promised
services and potential performance obligations.
The accounting policy election must be applied consistently to similar types of transactions.
3.3 DISTINCT GOODS OR SERVICES
FASB REFERENCES
ASC 606-10-25-19 through 25-22
After identifying the promised goods or services in the contract, an entity determines which of those promised goods or
services (or bundle of goods and services) are “distinct” and, hence, represent separate performance obligations. If a
promised good or service is not distinct, the entity must combine that good or service with other promised goods or
services until a bundle of goods or services that is distinct can be identified.
The following diagram illustrates the guidance on determining whether a promised good or service is distinct, and
hence a separate performance obligation:
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As illustrated in the diagram, for a good or service to be distinct, both of the following criteria must be met:
The good or service is capable of being distinct — That is, the customer can benefit from the good or service
either on its own or with other resources that are readily available to the customer.
The promise to transfer the good or service is distinct within the context of the contract — That is, the entity’s
promise to transfer the good or service to the customer is separately identifiable from other promises in the
contract.
Can the customer benefit from the good or service, either on its
own, or with other ‘readily available resources?’
(‘Readily available resources’ are those that the customer possesses
or is able to obtain from the entity or another third party.)
Promised goods or
services are distinct.
Promised goods
or services are
not distinct and
are grouped with
other promised
goods or services
that are together
distinct.
Are the promised goods or services capable of being distinct?
Are the promised goods or services distinct within the context of
the contract?
Criterion 1
Is the promise to transfer a good or service separate from the
other promised goods or services in the contract?
Indicators a promise is not distinct include:
The entity provides
a significant service
of integrating the
good or service with
other goods or
services promised in
the contract.
The good or service
significantly
modifies or
customizes the
other goods or
services promised in
the contract.
The good or service
is highly dependent
or interrelated with
one or more of the
other goods or
services promised in
the contract.
Criterion 2
No
No
Yes
Yes
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3.3.1 Criterion 1 — Good or Service Is Capable of Being Distinct
FASB REFERENCES
ASC 606-10-25-19(a) and ASC 606-10-25-20
A good or service is capable of being distinct if a customer can benefit from the good or service either on its own or
with other resources that are readily available to the customer. A customer can benefit from a good or service if the
good or service can be used, consumed, or sold (other than for scrap value), or held in any other way to generate
economic benefits. While a customer may benefit from some goods or services on its own in other circumstances, it
may only be able to obtain benefits from goods or services in conjunction with other readily available resources.
A readily available resource is either:
A good or service that is sold separately (either by the entity or a third party)
A resource that the customer has already obtained from the entity, including a good or service that the entity has
already transferred to the customer under the contract or from other transactions or events
Whether the customer can benefit from a good or service either on its own or in conjunction with other readily
available resources can be corroborated by various factors. For example, if an entity regularly sells a good or service
separately, this indicates that a customer can benefit from that good or service either on its own or in conjunction
with other readily available resources. If a good or service is not capable of being used on its own or with other
resources, conceptually there would not be a market for an entity to provide that good or service on a standalone
basis.
3.3.1.1 Customer Can Benefit From the Goods or Services on Its Own
FASB REFERENCES
ASC 606-10-25-19(a), ASC 606-10-55-150A through 55-150F
The assessment of whether the “customer can benefit from the goods or services on its own” is based on the
characteristics of the goods or services themselves rather than the way in which the customer contractually may use or
obtain the goods or services. Therefore, an entity disregards any contractual limitations that might prevent the
customer from obtaining readily available resources from a source other than the entity.
“Capable of being distinct” is the minimum characteristic that a promised good or service must possess to be
considered for separate accounting in a contract with a customer. If this criterion is not met, then the promised good
or service is not distinct, and an evaluation of the second criterion is not necessary. Rather, that promised good, or
service is combined with other promised goods or services in the contract until a distinct bundle of goods or services is
identified.
EXAMPLE 3-2 (ADAPTED FROM ASC 606-10-55-150A THROUGH 55-150D): GOODS AND SERVICES ARE CAPABLE OF
BEING DISTINCT
Entity A contracts with a customer to sell machinery and installation services. Installation of the machinery is not
complex and can be provided by Entity A or other entities. Entity A identifies two promised goods and services in
the contract: (a) machinery and (b) installation services. Entity A observes that the customer can benefit from the
machinery on its own, by using it or reselling it for an amount greater than scrap value, or with other readily
available resources (that is, installation services available from other entities). Additionally, the customer can
benefit from the installation service promised by Entity A with other resources that the customer will already have
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obtained from the entity under the contract (that is, the machinery). Therefore, Entity A determines that the
machinery and installation services are capable of being distinct.
EXAMPLE 3-3 (ADAPTED FROM ASC 606-10-55-150A THROUGH 55-150F): GOODS AND SERVICES ARE CAPABLE OF
BEING DISTINCT
Assume the same facts in Example 3-2 except the customer is contractually required to purchase the installation
service from Entity A rather than other entities. Entity A’s promises to transfer the machinery and installation
services to the customer are capable of being distinct for the reasons stated in Example 3-2, despite the contractual
limitations that prevent the customer from purchasing the installation service from other entities. This is because
the assessment of whether a customer can benefit from a good or service (the machinery or installation service) on
its own is based on the characteristics of the good or service itself (machinery or installation service) rather than
any contractual limitations. The contractual requirement to use Entity A’s installation service does not change the
characteristics of the machinery or installation service, nor does it change Entity A’s promise to the customer.
3.3.2 Criterion 2 — Promise to Transfer Good or Service Is Distinct Within the Context of the Contract
FASB REFERENCES
ASC 606-10-25-19(b) and ASC 606-10-25-21
An entity’s promise to transfer a good or service is distinct within the context of the contract if that promise is
separately identifiable from other promises in the contract. The objective of assessing whether an entity’s promise to
transfer a good or service is separately identifiable from other promised goods or services in the contract is to
determine whether the nature of the promise, within the context of the contract, is to transfer each of those goods or
services individually or, instead, to transfer a combined item(s) to which the promised goods or services are inputs.
In certain cases, even though the individual goods or services promised as a bundle of goods or services might be
capable of being distinct, accounting for those goods or services separately may not result in a faithful depiction of the
entity’s performance in that contract. For example, many construction- and production-type contracts involve
transferring many goods and services that are capable of being distinct (for example, various building materials, labor,
and project management services) to the customer. However, identifying all those individual goods and services as
separate performance obligations would be impractical. More importantly, it would not faithfully represent the nature
of the entity’s promise to the customer. Therefore, when identifying whether promised goods or services in a contract
are distinct, an entity considers both the characteristics of an individual good or service (that is, whether the good or
service is capable of being distinct) and whether the promise to transfer the good or service is separately identifiable
(that is, distinct within the context of the contract).
Determining whether an entity’s promise to transfer a good or service is separately identifiable in a contract requires
significant judgment and consideration of all facts and circumstances for each individual contract with a customer.
ASC 606 specifies three factors to assist an entity in making that judgment. Those factors, stated below, indicate that
an entity’s promise to transfer two or more goods or services to the customer are not separately identifiable:
The entity provides a significant service of integrating goods or services with other goods or services promised in the
contract into a bundle of goods or services that represents the combined output(s) for which the customer has
contracted.
One or more of the goods or services significantly modify or customize or are significantly modified or customized by
one or more of the other goods or services promised in the contract.
The goods or services are highly interdependent or highly interrelated.
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The “separately identifiable” principle is influenced by the notion of separable risks, which is whether the risk that an
entity assumes to fulfill its obligation to transfer one of those promised goods or services to the customer is
inseparable from the risk relating to the transfer of the other promised goods or services in the contract.
The FASB stated in BC29 of ASU 2016-10 that its intent is that an entity must evaluate whether a contract is to deliver:
Multiple promised goods or services that are outputs themselves
A combined item(s) that consists of the multiple promised goods or services that are inputs to a combined item(s)
For multiple promised goods or services to be considered inputs to a combined item(s), an entity’s promise to transfer
the promised goods or services must result in a combined item(s) that is(are) greater than (or substantively different
from) the sum of those promised goods and services.
Additionally, in BC32 of ASU 2016-10, the FASB clarified that the “separately identifiable” principle is intended to
consider the level of integration, interrelation, or interdependence among promises to transfer goods or services. That
is, the separately identifiable principle is intended to evaluate when an entity’s performance in transferring a bundle
of goods or services in a contract is, in substance, fulfilling a single promise to a customer. Therefore, the entity
evaluates whether two or more promised goods or services (for example, a delivered item and an undelivered item)
each significantly affect the other (and, therefore, are highly interdependent or highly interrelated) in the contract.
The entity cannot merely evaluate whether one item, by its nature, depends on the other (for example, an undelivered
item that would never be obtained by a customer absent the presence of the delivered item in the contract or the
customer having obtained that item in a different contract).
Entities must consider the three factors with the “separately identifiable” principle. The three factors are not an
exhaustive list, and not all of them need to be met (or not met) to conclude that the entity’s promises to transfer
goods or services are not (are) separately identifiable. Furthermore, sometimes the factors are less relevant to the
evaluation of the “separately identifiable” principle and, therefore, entities must consider the principle, not only the
three factors.
Additionally, the three factors are not mutually exclusive. On the contrary, because the factors are based on the same
underlying principle of inseparable risks, it is possible that more than one of the factors might apply to a contract with
a customer. However, each of the three factors was included in the standard because each one may be more or less
applicable for particular contracts or industries.
3.3.2.1 Significant Integration Service
FASB REFERENCES
ASC 606-10-25-21(a), ASC 606-10-55-137 through 55-140
Two or more promises to transfer goods or services to a customer are not separately identifiable if an entity provides a
significant service of integrating those goods or services with other goods or services promised in the contract into a
bundle that represents the combined output or outputs for which the customer has contracted.
In other words, the entity is using the goods or services as inputs to produce or deliver the combined output(s)
specified by the customer. A combined output may include more than one phase, element, or unit. Therefore, as
stated in BC107 of ASU 2014-09, when an entity provides an integration service, the risk of transferring the individual
goods or services is inseparable, because a substantial part of the entity’s promise is to incorporate the individual
goods and services into the combined output.
The factor on significant integration service may be relevant in many construction contracts in which the contractor
provides an integration (or contract management) service to manage and coordinate the various construction tasks.
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EXAMPLE 3-4 (ADAPTED FROM ASC 606-10-55-137 THROUGH 55-140): SIGNIFICANT INTEGRATION SERVICE IN
CONSTRUCTION CONTRACT
A contractor enters a contract with a customer to construct a building. The contractor is responsible for the overall
management of the project and has promised multiple goods and services in the contract, including engineering,
site clearance, foundation, procurement, construction of the structure, piping and wiring, equipment installation
and finishing.
The contractor considers that each of those goods and services are regularly sold separately by it or its competitors.
Additionally, the customer could generate economic benefit from the individual goods and services by using,
consuming, selling, or holding those goods or services. Therefore, the contractor determines that the customer can
benefit from each of the goods or services either on its own or with other readily available resources, and each
good or service is capable of being distinct.
The contractor determines that the promises to transfer the goods and services are not separately identifiable
because the contractor provides a significant service of integrating the goods and services (the inputs) into the
building (the combined output) for which the customer has contracted.
Therefore, the individual goods and services in the contract are not distinct and the contractor accounts for all of
the goods and services in the contract as a single performance obligation.
3.3.2.2 Significant Modification or Customization
FASB REFERENCES
ASC 606-10-25-21(b)
Two or more promises to transfer goods or services to a customer are not separately identifiable if one or more of the
goods or services significantly modifies or customizes, or is significantly modified or customized by, another good or
service promised in the contract.
In some industries, for example, the software industry, the notion of inseparable risks (that is, the concept that the
risk that an entity assumes to fulfill its obligation to transfer one of the promised goods or services to the customer is
inseparable from the risk relating to the transfer of the other promised goods or services in the contract) is more
clearly illustrated by assessing whether one good or service significantly modifies or customizes another good or
service. If a good or service significantly modifies or customizes another good or service in the contract, each good or
service is being assembled (that is, as an input) to produce a combined output for which the customer has contracted.
See Examples 3-10 and 3-11 in this chapter.
3.3.2.3 High Interdependency or Interrelation
FASB REFERENCES
ASC 606-10-25-21(c), ASC 606-10-55-137 through 55-150J
Two or more promises to transfer goods or services to a customer are not separately identifiable if the goods or
services are highly interdependent or highly interrelated. That is, each of the goods or services is significantly affected
by one or more of the other goods or services in the contract. For example, two or more goods or services may be
significantly affected by each other because the entity would not be able to fulfill its promise by transferring each of
the goods or services independently.
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In some cases, whether an entity is providing an integration service or whether the goods or services are significantly
modified or customized may be unclear. Nevertheless, the individual goods and services in the contract may still not be
separately identifiable from the other goods or services promised in the contract because the goods or services are
highly dependent on, or highly interrelated with, other promised goods or services in the contract in such a way that
the customer could not choose to purchase one good or service without significantly affecting the other promised goods
or services in the contract.
When considering whether the promises in a contract are highly interdependent or interrelated, it is important for an
entity to consider whether one promise in a contract has a transformative effect on another promise rather than
merely an additive effect. The fact that a good or service depends on a second good or service (that is, they have a
functional relationship) does not necessarily mean the two promises are not distinct in the context of the contract.
For example, equipment and related consumables needed to operate the equipment are distinct even though the value
of the consumables depends on access to the equipment, because the supply of consumables does not result in any
changes to the equipment. Instead, the dependency between the promises must be bi-directional, that is, they must
each impact the other — see Example 3-8 in this chapter. Additionally, Example 3-5 in this chapter illustrates two
promises that each impact the other, resulting in a conclusion that they are not distinct in the context of the contract.
BDO INSIGHTS — IDENTIFICATION OF DISTINCT GOODS OR SERVICES REQUIRES CAREFUL ANALYSIS
The identification of distinct goods or services in a contract requires the application of professional judgment,
based on the facts and circumstances. An entity may need to perform a detailed analysis of contractual terms and
apply significant judgment to determine whether a promise in a contract is a distinct good or service (and, hence,
constitutes a performance obligation) or must be combined (“bundled”) with other promises in the contract to
create a single performance obligation. Subtle differences in contractual terms and conditions, unique facts and
circumstances and customer expectations can affect this analysis.
EXAMPLE 3-5 (ADAPTED FROM ASC 606-10-55-140A THROUGH 55-140C): SIGNIFICANT INTEGRATION SERVICE
AND HIGH INTERDEPENDENCY AND INTERRELATION IN MANUFACTURING CONTRACT
A manufacturer enters a contract with a customer to deliver multiple units of a highly complex, specialized device.
The contract requires the manufacturer to establish a manufacturing process to produce the contracted units. The
specifications are unique to the customer based on a custom design owned by the customer and were developed
under the terms of a separate contract that is not part of the current negotiated exchange. The manufacturer is
responsible for the overall contract management, which requires the performance and integration of various
activities, including procurement of materials, identifying and managing subcontractors, and performing
manufacturing, assembly, and testing.
The manufacturer considers that each unit of the device can function independently of the other units and,
therefore, the customer can benefit from each device on its own. Therefore, the manufacturer determines that
each unit of the device is capable of being distinct.
The manufacturer considers the nature of its promise in the contracts and observes that it has promised to establish
and provide a service of producing the full complement of devices for which the customer has contracted. The
manufacturer is responsible for overall contract management and for providing a significant service of integrating
various goods and services (the inputs) into its overall service and the resulting devices (the combined output).
Therefore, the manufacturer determines that the devices and the various promised goods and services inherent in
manufacturing those devices are not separately identifiable.
The manufacturer provides a manufacturing process specific to its contract with a customer. In addition, the nature
of the manufacturer’s performance and, particularly, the significant integration of various activities mean that a
change in one of the manufacturer’s activities to produce the highly complex specialized devices has a significant
effect on the other activities required to produce those devices, such that the entity’s activities are highly
interdependent and highly interrelated.
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Therefore, the manufacturer concludes that the goods and services in the contract are not distinct and accounts for
all of the goods and services as a single performance obligation.
TRG DISCUSSIONS — EFFECT OF CONTRACTUAL RESTRICTIONS ON IDENTIFYING PERFORMANCE
OBLIGATIONS
Stakeholders raised questions about the effect of contractual restrictions on the identification of performance
obligations. Therefore, the FASB added an example to illustrate that a contract for the sale of specialized
equipment and the installation of the equipment could be distinct within the context of the overall contract even if
the entity requires the customer to buy installation services when it buys equipment. Other relevant factors might
include:
The extent to which the equipment could operate without the installation
Whether other entities would have been able to undertake the installation absent the contractual restriction
The extent to which the installation services significantly modify or customize the equipment being installed
Whether the customer could benefit economically from the machine if it did not receive the installation services
EXAMPLE 3-6 (ADAPTED FROM ASC 606-10-55-150A THROUGH 55-150C): PROMISES ARE SEPARATELY
IDENTIFIABLE — INSTALLATION
This example is a continuation of Example 3-2. The content from Example 3-2 has been reproduced here for
improved readability.
Entity A contracts with a customer to sell machinery and installation services. Installation of the machinery is not
complex and can be provided by Entity A or other entities. Entity A identifies two promised goods and services in
the contract: (a) machinery and (b) installation service.
Capable of Being Distinct
Entity A observes that the customer can benefit from the machinery on its own, by using it or reselling it for an
amount greater than scrap value, or with other readily available resources (that is, installation services available
from other entities). Additionally, the customer can benefit from the installation service promised by Entity A with
other resources that the customer will already have obtained from the entity under the contract (that is, the
machinery). Therefore, Entity A determines that the machinery and installation services are capable of being
distinct.
Distinct in the Context of the Contract
Entity A then determines whether its promises to transfer the machinery and to provide the installation services are
each separately identifiable. Entity A considers the following to determine whether the machinery and the
installation services are inputs to a combined item:
Entity A is not providing a significant integration service. That is, Entity A has promised to deliver the machinery
and then install it; Entity A would be able to fulfill its promise to transfer the equipment separately from its
promise to subsequently install it. Entity A has not promised to combine the machinery and the installation
services in a way that would transform them into a combined output.
Entity A’s installation services will not significantly customize or significantly modify the machinery.
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Although the customer can benefit from the installation services only after it has obtained control of the
machinery, the installation services do not significantly affect the machinery because Entity A would be able to
fulfill its promise to transfer the machinery independently of its promise to provide the installation services. In
other words, there is no two-way interdependency between the machinery and installation services. Because the
machinery and the installation services do not significantly affect each other, they are not highly interdependent
or highly interrelated.
Based on this assessment, Entity A determines that the machinery and installation services are not inputs to a
combined item and identifies two performance obligations (the machinery and installation services) in the contract.
Note that each of the three factors contributes to, but is not individually determinative of, the conclusion that the
equipment and the installation services are separately identifiable.
EXAMPLE 3-7 (ADAPTED FROM ASC 606-10-55-150A THROUGH 55-150F): PROMISES ARE SEPARATELY
IDENTIFIABLE — INSTALLATION
Assume the same facts in Example 3-6 except the customer is contractually required to purchase the installation
service from Entity A rather than from other entities.
Capable of Being Distinct
Entity’s A promises to transfer the machinery and installation services to the customer are “capable of being
distinct” for the reasons stated in Example 3-6, despite the contractual limitations that prevent the customer from
purchasing the installation service from other entities. This is because the assessment of whether a customer can
benefit from a good or service on its own is based on the characteristics of the good or service itself (the machinery
or installation service in this example) rather than any contractual limitations. The contractual requirement to use
Entity A’s installation service does not change the characteristics of the machinery or installation service, nor does
it change Entity A’s promise to the customer.
Distinct in the Context of the Contract
Entity A’s analysis of and conclusion on whether the machinery and installation services are separately identifiable
is consistent with Example 3-6. That is, Entity A identifies two performance obligations (the machinery and
installation services) in the contract.
EXAMPLE 3-8 (ADAPTED FROM ASC 606-10-55-150G THROUGH 55-150J): SEPARATELY IDENTIFIABLE —
EQUIPMENT AND CONSUMABLES
An entity enters a contract with a customer to deliver a printer (which is off-the-shelf and operational without any
significant customization or modification) and specialized ink cartridges that are required to operate the printer.
The entity is contractually required to provide replacement cartridges on specified dates over the next three years.
The cartridges are specific to the printer and produced only by the entity. The entity sells the cartridges separately
to customers who have bought the printer from the entity or from other parties.
Capable of Being Distinct
The entity determines that the printer and the cartridges are each capable of being distinct because:
The customer can benefit from the printer with the readily available cartridges. The cartridges are readily
available because they are regularly sold separately by the entity (that is, through refill orders to customers who
previously purchased the printer).
The customer can benefit from the cartridges that will be delivered under the contract with the printer that will
be delivered to the customer initially under the contract.
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Therefore, the entity determines that the printer and the cartridges are each capable of being distinct.
Distinct in the Context of the Contract
The entity determines that its promises to transfer the printer and to provide cartridges over a three-year period
are each separately identifiable because:
The printer and the cartridges are not inputs to a combined item in the contract because the entity is not
providing a significant integration service that transforms the printer and cartridges into a combined output.
Neither the printer nor the cartridges are significantly customized or modified by the other.
The printer and the cartridges are not highly interdependent or highly interrelated because they do not
significantly affect each other.
Although the customer can benefit from the cartridges only after it has obtained control of the printer (that is, the
cartridges would have no use without the printer) and the cartridges are required for the printer to function, the
printer and the cartridges do not each significantly affect the other. This is because the entity would be able to
fulfill each of its promises in the contract independently of the other. That is, the entity would be able to fulfill its
promise to transfer the printer even if the customer did not purchase any cartridges and would be able to fulfill its
promise to provide the cartridges even if the customer acquired the printer separately.
Therefore, the entity identifies two performance obligations in the contract: the printer and the cartridges.
3.3.2.4 Utility of Promised Good or Service — Customer’s Perspective
FASB REFERENCES
ASC 606-10-55-140D through 55-150
In BC33 of ASU 2016-10, the FASB stated that when evaluating whether two or more promises in a contract are
separately identifiable, consideration is given to the utility of the promised goods or services (that is, the ability of
each good or service to provide benefit or value) to the customer. While an entity may be able to fulfill its promise to
transfer each good or service in a contract independently of the other, each good or service may significantly affect
the other’s utility to the customer.
The “capable of being distinct” criterion considers the utility of the promised good or service, but merely establishes
the baseline level of economic substance a good or service must achieve. Utility also is relevant in evaluating whether
two or more promises in a contract are separately identifiable because even if two or more goods or services are
capable of being distinct because the customer can derive some economic benefit from each one, the customer’s
ability to derive its intended benefit from the contract may depend on the entity transferring each of those goods or
services.
For example, in Example 3-9 in this chapter on anti-virus software license with updates, the entity’s ability to transfer
the initial license is not affected by its promise to transfer the updates or vice versa, but the provision (or not) of the
updates will significantly affect the utility of the licensed IP to the customer such that the license and the updates are
not separately identifiable. They are, in effect, inputs to the combined solution for which the customer contracted.
EXAMPLE 3-9 (ADAPTED FROM ASC 606-10-55-140D THROUGH 55-140F): LICENSE TO ANTI-VIRUS SOFTWARE
WITH WHEN-AND-IF AVAILABLE UPDATES
A software entity grants a customer a three-year term license to an anti-virus software and promises to provide the
customer with when-and-if available updates to that software during the license period. The software entity often
provides updates that are critical to the continued utility of the anti-virus software. Without those updates, the
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customer’s ability to benefit from the anti-virus software would decline significantly during the three-year
arrangement.
Capable of Being Distinct
The software entity determines that the anti-virus software and the updates are each capable of being distinct
because:
The customer can derive economic benefit from the software on its own throughout the license period (that is,
without the updates the software would still provide its original functionality to the customer).
The customer can benefit from the updates with the software license transferred at the outset of the contract.
Distinct in the Context of the Contract
The software entity determines that its promises to transfer the anti-virus software and the unspecified updates,
when-and-if available, are not separately identifiable. This is because the license and the updates are, in effect,
inputs to a combined item (anti-virus protection) in the contract. The unspecified updates will significantly modify
the functionality of the anti-virus software (that is, they permit the software to protect the customer from a
significant number of additional viruses that the software did not protect against previously) and are integral to
maintaining the utility of the software license to the customer.
Consequently, the anti-virus license and periodic unspecified updates fulfill a single promise to the customer in the
contract — a promise to provide protection from computer viruses for three years. Therefore, the software entity
accounts for the software license and the when-and-if available updates as a single performance obligation in the
contract.
See Section 7.5 for additional discussion on licensing arrangements.
SEC STAFF GUIDANCE
Remarks before the 2019 AICPA Conference on Current SEC and PCAOB Developments
Susan M. Mercier, Professional Accounting Fellow, Office of the Chief Accountant
December 9, 2019
License to Software with Updates — Single Performance Obligation
An SEC staff speech elaborated on a consultation in which the SEC staff did not object to the
conclusion that a software license and updates represent a single, combined performance
obligation. In the fact pattern consulted on, a software entity licenses its software that allows
its customers, application (app) developers, to build and deploy, and therefore monetize, their
own apps on various third-party platforms. The third-party platforms include phones and home
entertainment systems, which often undergo software updates as well. The software entity’s
software and updates make sure that the app built by customers using the software is
compatible with all platforms that it supports, both when the app is initially deployed on a
platform and over time as that platform is updated. To maintain continued compatibility of the
software with third-party platforms, the software entity partners with the third-party
platforms to understand their timelines for internal updates so that the software entity can
timely initiate corresponding updates to its software. Without those software updates, the
customer’s ability to benefit from the software would be significantly limited over the contract
term.
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The SEC staff did not object to the software entity’s conclusion that the software license and
updates represent a single performance obligation because, in the SEC staff’s view, the
promises to provide the software license and the updates are, in effect, inputs that fulfill a
single promise to the customer, which is to continually be able to deploy and monetize content
using third-party platforms of the customer’s choice in a rapidly changing environment, and
that the updates are integral to maintaining the utility of the software license. The SEC staff
stated that in this fact pattern, the combined output (whether marketed as a “solution” or not)
is greater than, or substantively different than, the individual promises (that is, the software
license and the updates).
BDO INSIGHTS — DETERMINING WHETHER A SOFTWARE LICENSE AND UPDATES ARE A SINGLE PERFORMANCE
OBLIGATION
In the fact pattern discussed above in the SEC staff speech and the example of an anti-virus software license
(Example 3-9 in this chapter), the entity concluded that the software license and related updates are a single
performance obligation. We believe it may be possible to reach the same conclusion in additional fact patterns,
although we believe that will be rare.
Key factors we believe may be helpful in determining whether a software license and updates are a single
performance obligation include:
How frequent the updates are
Whether the updates are driven by factors within the software entity’s control
How significantly the functionality of the software is impacted by the upgrades
How often and how many customers elect not to adopt an upgrade and continue to derive the intended benefit
from the software license
The factor on significant customization or modification may be relevant in a software development contract in which a
software developer customizes a software product for a specific customer. ASC 606 includes two fact patterns to
illustrate whether a significant customization service provided by a software developer in a contract with a customer is
distinct from a software license — see adaptations below.
EXAMPLE 3-10 (ADAPTED FROM ASC 606-10-55-141 THROUGH 55-145): SOFTWARE DEVELOPMENT CONTRACT —
SIGNIFICANT CUSTOMIZATION OR MODIFICATION IS NOT PROVIDED
A software developer contracts with a customer to transfer a software license, perform an installation service, and
provide unspecified software updates and technical support for a specified period. The software developer sells the
license, installation service and technical support separately. The installation service includes changing the web
screen for each type of user (for example, marketing, inventory management, and IT). Other competitor entities
routinely perform the installation service, which does not significantly modify the software. The software remains
functional without the updates and the technical support.
Capable of Being Distinct
The software developer assesses the promised goods and services and concludes that the customer can benefit from
each of the goods and services either on its own or with the other goods and services that are readily available (that
is, the goods and services are capable of being distinct). This is because:
The software is delivered before the other goods and services and remains functional without the updates and
the technical support.
The customer can benefit from the updates with the software license transferred at the outset of the contract.
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Distinct in the Context of the Contract
The software developer determines that the promise to transfer each good and service to the customer is
separately identifiable from each of the other promises (that is, the goods and services are distinct in the context
of the contract) because:
Although it integrates the software into the customer’s system, the installation services do not significantly
affect the customer’s ability to use and benefit from the software license because the installation services are
routine and can be obtained from other providers.
The software updates do not significantly affect the customer’s ability to use and benefit from the software
license because the software updates are not necessary for the software to maintain a high level of utility to the
customer during the license period.
None of the promised goods or services significantly modify or customize one another.
The software developer is not providing a significant service of integrating the software and the services into a
combined output.
The software and the services do not significantly affect each other and, therefore, are not highly
interdependent or highly interrelated because the software developer would be able to fulfill its promise to
transfer the initial software license independent from its promise to subsequently provide the installation
service, software updates, or technical support.
Based on the above analysis, the software developer concludes that there are four performance obligations in the
contract:
Software license
Installation service
Software updates
Technical support
EXAMPLE 3-11 (ADAPTED FROM ASC 606-10-55-146 THROUGH 55-150): SOFTWARE DEVELOPMENT CONTRACT —
SIGNIFICANT CUSTOMIZATION IS PROVIDED
Consider the same fact pattern in Example 3-10, except that the contract requires the software developer, as part
of the installation service, to substantially customize the software to add significant new functionality to enable the
software to interface with other customized software applications used by the customer. Other competitor entities
can provide the customized installation service.
Capable of Being Distinct
For the same reasons in Example 3-10, the software developer concludes that the software license, installation
service, software updates, and technical support are each capable of being distinct.
Distinct in the Context of the Contract
The software developer then considers the following:
The contractual terms result in a promise to provide a significant service of integrating the licensed software
into the existing software system by performing a customized installation service as specified in the contract. In
other words, the software developer is using the license and the customized installation service as inputs to
produce the combined output (that is, a functional and integrated software system) in accordance with the
customer’s specifications.
The software is significantly modified and customized by the installation service.
Consequently, the software developer determines that the promise to transfer the software license is not
separately identifiable from the customized installation service and they are not distinct in the context of the
REVENUE RECOGNITION UNDER ASC 606 65
contract. Therefore, the software license and the customized installation service are combined into a single
performance obligation.
Based on the same analysis as in Example 3-10, the software developer concludes that the software updates and
technical support are distinct from the other promises in the contract.
Therefore, the software developer concludes that there are three performance obligations in the contract:
Software customization (comprised of the software license and the customized installation service)
Software updates
Technical support
3.3.3 Firmware
FASB REFERENCES
ASC 606-10-55-56(a)
Many consumer products include embedded software that is required for the product to function as intended. This type
of software is often called firmware. A license that forms a component of a tangible good and is integral to the
functionality of the good is not distinct from the good. In that case, the tangible good and license are accounted for as
a single performance obligation. As a result, a firmware is typically combined with the related product and accounted
for as a single performance obligation.
In a growing number of instances, an entity may also provide functionality related to a consumer product through a
mobile application that is made available for free. An entity needs to determine whether:
The application is integral to the functionality of the product and is thus combined with the product and firmware
as a single bundled performance obligation
The application represents incremental functionality that is a distinct performance obligation
Consider the following examples:
EXAMPLE 3-12: HARDWARE WITH EMBEDDED FIRMWARE AND MOBILE APPLICATION
A medical device entity sells a blood glucose monitor. When purchasing a monitor, a customer also receives a
limited license to the firmware that is embedded on the monitor and without which it cannot determine blood
glucose levels as promised. In addition, the entity makes available a mobile application that the customer can
download for free onto a mobile device to use with the monitor.
The blood glucose monitor includes a user interface, which, when used properly, visually reports blood glucose
levels of the user. The mobile application provides more functionality, including wirelessly syncing to the monitor to
receive measurements, storing the measurements, and predicting when a user may experience high or low measures
based on that history.
The medical device entity concludes that the embedded firmware is a component of the blood glucose monitor and
is integral to its functionality. As such, the license is not capable of being distinct.
The medical device entity then considers whether the mobile application is capable of being distinct from the blood
glucose monitor. The entity concludes that the blood glucose monitor is capable of being distinct because a user
can obtain the promised benefit of determining blood glucose levels without downloading the mobile application. In
addition, because the mobile application can be used in conjunction with other resources that a customer already
owns, namely the blood glucose monitor, it is also capable of being distinct from the monitor.
REVENUE RECOGNITION UNDER ASC 606 66
The medical device entity then determines whether the mobile application is distinct in the context of the
contract. The entity notes that while the mobile application is dependent upon the blood glucose monitor, the
monitor is not dependent upon the mobile application. That is, the interdependency between the mobile
application and the monitor is not bi-directional. In addition, neither the mobile application nor the monitor
modifies or customizes the other, and the entity does not perform a significant service of integrating the monitor
and mobile application into a combined output.
Therefore, the medical device entity concludes that the mobile application is distinct from the blood glucose
monitor.
Note that the medical device entity must evaluate whether the mobile application is a functional IP license that is
generally satisfied at a point in time. See Section 7.5 for discussion on IP licenses and related revenue recognition
considerations.
EXAMPLE 3-13: HARDWARE WITH EMBEDDED FIRMWARE AND MOBILE APPLICATION
Assume the same fact pattern as in Example 3-13 except the blood glucose monitor does not include a user
interface. Instead, it automatically delivers the measurements wirelessly to the mobile application. A user must
utilize the mobile application to receive the blood glucose measurement taken by the monitor. The mobile
application also provides tracking and charting of historical measurements, and predictive analysis based on that
history.
Consistent with Example 3-13, the medical device entity concludes that the firmware is not distinct from the blood
glucose monitor.
However, in this example, the medical device entity concludes that the mobile application is also not capable of
being distinct. Specifically, the blood glucose monitor cannot function as intended by a user without the mobile
application, because the mobile application is the only mechanism by which the user can obtain his or her blood
glucose measurements. Therefore, the entity concludes that it has a single performance obligation consisting of the
blood glucose monitor, the firmware, and the mobile application.
Note that the medical device entity must evaluate whether the mobile application is a functional IP license that is
generally satisfied at a point in time. Presuming the application is a functional IP license that is always available on
an application store for the customer to download, the application is generally considered to be delivered at the
same time as the hardware and firmware. See Section 7.5 for discussion on IP licenses and related revenue
recognition considerations.
3.3.4 Combining a Good or Service With Other Promised Goods or Services
FASB REFERENCES
ASC 606-10-25-22
If a good or service is not distinct, an entity must 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, this may result in an entity accounting
for all the goods or services promised in a contract as a single performance obligation.
3.3.5 Application of Step 2 for Concurrently Satisfied Performance Obligations
ASC 606 does not specify the accounting for concurrently delivered distinct goods or services that have the same
pattern of transfer. Based on the FASB’s observation in BC116 of ASU 2014-09, an entity is not precluded from
accounting for the goods or services in a contract that are delivered concurrently as if they were a single performance
REVENUE RECOGNITION UNDER ASC 606 67
obligation if the outcome is the same as accounting for the goods and services as individual performance obligations.
See Chapter 6 for discussion on the pattern of transfer of a good or service.
BDO INSIGHTS — MODIFICATION OF A CONTRACT THAT INCLUDES CONCURRENTLY SATISFIED PERFORMANCE
OBLIGATIONS
Even if a contract includes multiple performance obligations that are satisfied concurrently and could practically be
accounted for as a single performance obligation, an entity is required to correctly identify separate performance
obligations in the original contract if that contract is modified. This is because accounting for a contract
modification is based on, among other things, whether a promised good or service is distinct (and therefore a
performance obligation) and whether a performance obligation in a contract has been satisfied before the
modification date. Those considerations affect the amount and timing of revenue recognized at or after the
modification date. See Section 7.3 for discussion on accounting for contract modifications.
Identifying performance obligations and accounting for contract modifications requires the application of
professional judgment, based on the facts and circumstances.
3.4 SERIES OF DISTINCT GOODS OR SERVICES
FASB REFERENCES
ASC 606-10-25-14 through 25-15 and ASC 606-10-55-157B through 55-157E
A series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the
customer are considered one performance obligation in the contract for applying the five-step revenue recognition
model. A series of distinct goods or services has the same pattern of transfer to the customer if both of the following
criteria are met:
Each distinct good or service in the series that the entity promises to transfer to the customer would meet the
criteria in ASC 606-10-25-27 to be a performance obligation satisfied over time.
The same method would be used to measure the entity’s progress toward complete satisfaction of the performance
obligation to transfer each distinct good or service in the series to the customer.
See Chapter 6 for discussion on whether a performance obligation is satisfied over time and measurement of an
entity’s progress towards satisfying its performance obligation.
In determining whether the series guidance is applicable, an entity must first determine the nature of the goods or
services promised to the customer before assessing whether the promised services are distinct and substantially the
same. In some cases, this analysis may include determining whether the promise is the actual delivery of a specified
quantity of service or the act of standing ready to perform.
The following diagram gives an overview of the guidance for determining whether the series guidance is applicable:
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The series guidance was included as part of the definition of performance obligation to simplify the application of the
five-step revenue recognition model and to promote consistency in the identification of performance obligations in
circumstances in which the entity provides the same good or service repeatedly over a period of time. An entity may
provide the same good or service repeatedly over a period of time, for example, in a repetitive service contract, such
as a cleaning contract, transaction processing contract, or a contract to deliver electricity. If the series guidance were
not included in the definition of performance obligation, an entity would be required to identify multiple distinct goods
or services (or separate performance obligations), allocate the transaction price to each of the resulting performance
obligations based on its standalone selling price (SSP), and recognize revenue when (or as) those performance
obligations are satisfied. For example, an entity would be required to allocate the overall consideration to each
incremental hour of cleaning in a cleaning contract. The series guidance was included to provide a cost-effective and
more operable approach to apply the five-step revenue recognition model when an entity provides a series of distinct
goods or services that are substantially the same.
When the contract includes a promise to transfer a series of distinct goods or services that are substantially the same
and have the same pattern of transfer to the customer, an entity identifies a single performance obligation and
allocates the transaction price to that performance obligation. The entity then recognizes revenue by applying a single
measure of progress to that performance obligation. See Chapter 6 for discussion on the pattern of transfer of a
performance obligation (over time or point in time) and measure of progress when a performance obligation is satisfied
over time.
The series guidance is
applicable. The series of
distinct goods or services
is considered one
performance obligation.
Would each distinct good or service in the
series meet the criteria in ASC 606-10-25-
27 to be a performance obligation satisfied
over time?
Do the distinct
goods or services
have the same
pattern of
transfer to the
customer?
A series of
distinct goods or
services has the
same pattern of
transfer to the
customer if both
of these criteria
are met:
Would the same method be used to
measure the entity's progress toward
complete satisfaction of the performance
obligation to transfer each distinct good or
service in the series?
Are the distinct goods or services
substantially the same?
Yes
Yes
The series
guidance is not
applicable. The
distinct goods or
services are
separate
performance
obligations.
Consider the nature of the distinct goods or
services promised to the customer, for
example, whether the promise is to deliver a
specified quantity of service or stand ready
to perform.
Yes
No
No
No
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In assessing whether multiple goods or services are treated as a series, it is not necessary that:
The goods or services be transferred consecutively
The accounting result from applying the series guidance be substantially the same as would result from accounting
for each promised good or service as a separate performance obligation
EXAMPLE 3-14 (ADAPTED FROM ASC 606-10-55-157B THROUGH 55-157E): SERIES OF DISTINCT GOODS OR
SERVICES — SUBSTANTIALLY THE SAME
A hotel manager contracts with a customer to manage a customer-owned property for 20 years. The hotel manager
receives a monthly payment that is equal to 1% of the revenue from the customer-owned property.
The hotel manager evaluates the nature of its promise to the customer and determines that it has promised to
provide a hotel management service. That service consists of various activities that may vary each day, for
example, cleaning services, reservation services and property maintenance. However, those tasks are activities to
fulfill the hotel management service and are not separate promises in the contract.
The hotel manager concludes that each increment of the promised service (for example, each day of the hotel
management service) is distinct because:
The customer can benefit from each day of the hotel management service on its own (that is, each increment of
service is capable of being distinct), and
Each increment of service is separately identifiable because:
• No day of service significantly modifies or customizes another, and
• No day of service significantly affects either the entity’s ability to fulfill another day of service or the benefit
to the customer of another day of service.
Is each increment of service substantially the same?
The hotel manager considers that although the underlying tasks or activities it performs to provide hotel
management services may vary from day to day, the nature of its promise to its customer is the same each day,
which is to provide hotel management services. Therefore, the hotel manager concludes that the hotel management
services provided each day are substantially the same.
To determine whether the series guidance is applicable, the hotel manager would determine whether each distinct
increment of service has the same pattern of transfer. See Chapter 6 for discussion on whether a performance
obligation is satisfied over time and measurement of an entity’s progress towards satisfying its performance
obligation.
EXAMPLE 3-15: R&D SERVICES — APPLICABILITY OF THE SERIES GUIDANCE
A biotechnology entity enters a contract with a customer, Big Pharma, to provide R&D services to develop a new
drug compound. The R&D services are to be provided in various phases covering the initial development, trials, and
regulatory approvals. Each subsequent phase is dependent on the successful completion of the prior phase.
The biotechnology entity evaluates the nature of its promise to Big Pharma to determine whether the R&D activities
performed each day represent a series of distinct increments of time or service. The entity observes that:
The nature of its promise is to provide R&D services each day, which are comprised of various activities that may
vary each day.
Each day’s research and related results are dependent on or interrelated with the prior day’s research.
Therefore, each day of R&D services builds on and is interrelated with the other days of services.
The biotechnology entity determines that while the underlying activities may differ from day to day, its promise is
the same for each day, which is to provide R&D services. Additionally, the nature of its promise is cumulative such
that each increment of time or R&D service builds on and is dependent on the preceding increments of time or R&D
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service. Therefore, the entity determines that an increment of time or service is not distinct, and the series
guidance is not applicable.
TRG DISCUSSIONS — SERIES GUIDANCE — SUBSTANTIALLY THE SAME
How should an entity evaluate whether the performance obligation consists of distinct goods or services that are
substantially the same?
To be considered a series of goods or services, there must be two or more goods or services that are distinct, and
each distinct good or service must also be considered substantially the same. The first step is to determine the
nature of an entity’s promise in providing the goods or services to the customer. In some cases, an entity would
need to determine if the nature of the promise is the actual delivery of a specified quantity of service or the act of
standing ready to perform. This evaluation will require significant judgment. See the related TRG discussions below
in this section.
The TRG considered the FASB’s intention that a series could consist of distinct time increments (an hour of cleaning)
or the good or service delivered (each unit of electricity), depending on the nature of the promise. Therefore, an
entity should consider the following in applying the series guidance:
Is each time increment distinct?
If the nature of the entity’s promise is the act of standing ready or providing a single service for a period of time
(that is, because there is an unspecified quantity delivered), the evaluation would likely focus on whether each
time increment, rather than the underlying activities, are distinct and substantially the same.
• For example, in Example 3-14, nature of the hotel manager’s promise is to provide a daily management
service, and not a specified quantity of services, which could include management of the hotel employees,
accounting services, training and procurement. While the underlying activities could significantly vary within
a day and from day to day, that would not be relevant to the evaluation of the nature of the promise. In that
example, the hotel management performance obligation is a series of distinct days of service.
Is each unit of output distinct?
If the nature of the promise is the delivery of a specified quantity of a service, then the evaluation should
consider whether each service is distinct and substantially the same.
• ASC 606-10-55-160 illustrates an annual contract to provide monthly payroll processing services that are
considered a series. In that contract, the nature of the promise is to deliver 12 distinct instances of the
service, rather than a promise to stand ready to perform an undefined number of tasks.
TRG DISCUSSIONS — SERIES GUIDANCE — STAND-READY OBLIGATIONS
What is the nature of the promise to the customer in arrangements described as stand-ready obligations?
ASC 606-10-25-18 provides examples of promised goods or services, one of which is a service of standing ready to
provide goods or services or of making goods or services available for a customer to use as and when the customer
decides. If the goods or services provided meet the criteria in ASC 606-10-25-27 to be performance obligations that
are satisfied over time and have the same pattern of transfer (see Chapter 6 for discussion on assessing timing and
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pattern of revenue recognition), then a stand-ready obligation will generally meet the definition of a series and be
accounted for as a single performance obligation. However, determining whether the promise to the customer is a
stand-ready obligation can require significant judgment.
In January 2015, the TRG addressed this question by considering certain types of promises (Types A-D) and
discussing whether the nature of the good or service underlying the promises is the act of “standing ready,” or the
actual delivery of the underlying goods or services that the entity stands ready to provide to the customer.
Type A: Obligations in which the delivery of the good, service or IP underlying the obligation is within the control of
an entity, but the entity must still further develop its good, service or IP. For example, a software entity’s promise
to transfer unspecified software upgrades at the entity’s discretion, or a pharmaceutical entity’s promise to provide
when and-if-available updates to previously licensed IP to a drug formula based on advances in R&D.
Type B: Obligations in which the delivery of the underlying good or service is outside the control of the entity and
the customer. For example, an entity’s promise to remove snow from an airport’s runways in exchange for a fixed
fee for the year.
Type C: Obligations in which the delivery of the underlying good or service is within the control of the customer.
For example, an entity’s promise to provide periodic maintenance, when-and-if needed, on a customer’s equipment
after a specified amount of usage by the customer.
Type D: Making a good or service available to the customer continuously, for example, a health club membership.
In arrangements, such as in Type B, C, or D, in which an entity provides uncertain goods or services (for example,
while the entity knows it will provide maintenance services, it does not know the number of service calls it will
make or the parts it will be required to fix), the entity provides a service to the customer in “standing ready” to
perform.
Promises such as those in Type A (for example, to provide when-and-if available updates or upgrades in software or
biotechnology IP licensing arrangements) may require additional analysis to determine the nature of the promise
because the entity itself, rather than the customer or external events, might unilaterally control when updates or
upgrades become available for transfer to the customer. However, the nature of the entity’s promise in Type A
arrangements may be similar to those in Types B through D arrangements because an entity often will not be able to
predetermine the timing, number, or specific functionality or features of major IP improvements that will be
completed in the future and made available for transfer to a customer. For example, a biotechnology entity likely
cannot unilaterally determine when its scientists will make an R&D advancement for a drug formula. Similarly, a
software entity might have no major update or upgrade available for release during a contract period, especially if
the contract period is relatively short (for example, one year). In those examples, an entity’s performance on a
Type A arrangement, such as a when-and-if available upgrade right might, similar to those obligations in Types B
through D arrangements, be dependent upon events or circumstances that are largely outside the entity’s control.
Additionally, similar to the obligations in Types B through D arrangements, a Type A promise to unspecified when-
and-if available upgrades is also often about the customer obtaining assurance that it will have access to future
improvements to the product it has obtained, thus, providing the customer with a guarantee against obsolescence
or defects in that product. In the software license example, this guarantee provides a benefit to the customer by
protecting the customer’s investment in the software (which may include, for example, an expensive
implementation that would not be recovered economically if the customer had to implement a new software in the
near future) or the customer’s related business interests (for example, a customer that embeds the software in its
own products might want assurance that it will have access to upgrades of the software so that its products remain
competitive in the marketplace). Absent the right to unspecified upgrades, the entity might charge the customer
exorbitant fees in a separate negotiation for the next version of the software or might enter an exclusive
arrangement with another customer that restricts the customer’s ability to obtain the upgrades.
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In determining the nature of its promise to a customer in a Type A arrangement, an entity must carefully evaluate
whether it has promised one or more specified upgrades to a customer even if the contract refers only to
unspecified upgrades that will be transferred to the customer only when-and-if they become available. A promise to
deliver a specified upgrade is accounted for in the same manner as any other specifically promised good or service.
For example, a promise to deliver a specified upgrade to a software license is evaluated in the same manner as any
other software license.
EXAMPLE 3-16: SOFTWARE-AS-A-SERVICE WITH USAGE-BASED PRICING
A technology entity enters a contract to provide a customer access to its software-as-a-service (SaaS) platform for
two years. The customer will have the ability to process 100,000 transactions each year through the SaaS platform.
The customer is required to make annual payments of $120,000 each year. If needed, the customer is able to
process transactions beyond the annual volume of 100,000 transactions but is charged for the incremental
transactions at a higher rate. The entity does not expect the customer to exceed 100,000 transactions per year.
The technology entity evaluates the nature of its promise to determine whether it has an obligation to provide:
A specified amount of services (that is, 100,000 transactions per year processed through SaaS) where each
transaction is distinct and substantially the same
A stand-ready obligation, comprised of distinct increments of time, to provide SaaS to process all transactions if
and when required by the customer
The technology entity determines that it has a stand-ready obligation to provide SaaS for the entire contractual
period, regardless of the amount of services specified in the contract or expected to be sold. In making that
determination, the entity considers the following:
The customer benefits from the right to access the SaaS platform and process transactions in the amount and at
the time as needed. The entity stands ready to perform throughout the contract duration.
The entity is unable to predetermine the timing and volume of transactions and its performance is dependent
upon events or circumstances that are outside its control.
The entity stands ready to process unlimited transactions. While transactions that exceed the annual volume are
billed at a premium price, the customer does not have to separately contract for the right to transact those
volumes. The entity’s obligation to the customer does not diminish as transactions are processed. Selling a
specified volume at a fixed price and overages on a variable basis is a pricing strategy rather than determinative
of the entity’s obligations to the customer.
TRG DISCUSSIONS — SERIES GUIDANCE — CONSECUTIVE DELIVERY OF GOODS OR SERVICES
To apply the series provision, must the goods be delivered, or services performed consecutively?
No. In March 2015, the TRG considered whether the series guidance applies when there is a gap or an overlap in the
entity’s delivery of goods or performance of services and generally agreed with the FASB staff that whether the
goods or services are delivered or performed consecutively is not a determinative factor in assessing whether the
series guidance is applicable. While an entity may consider the pattern of performance in determining the measure
of progress towards satisfying a performance obligation, the consideration of whether the pattern of performance is
consecutive or not is not explicitly required in the series guidance.
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Both of the following fact patterns are accounted for as single performance obligations in accordance with the
series guidance:
Case A: An entity contracts with a customer to provide a manufacturing service in which it will produce 10,000 units
of a product every month for a two-year period. The entity will perform the service evenly over the two-year period
with no breaks in production. The entity does not incur any significant upfront costs to develop the production
process. The units produced are substantially the same and manufactured to the specifications of the customer.
Assume that the entity’s manufacturing service of producing each unit is a distinct service. Additionally, the service
is accounted for as a performance obligation satisfied over time (see Chapter 6) because:
The units are manufactured specific to the customer (that is, the entity’s performance does not create an asset
with alternative use to the entity).
If the contract is cancelled, the entity has an enforceable right to payment (cost plus a reasonable profit
margin).
Therefore, the criteria to apply the series guidance have both been met.
Case B: Assume the same facts in Case A, except that the entity does not plan to perform evenly over the two-year
service period. That is, the entity does not produce 10,000 units each month, continuously. Instead, the entity plans
to perform the manufacturing service over the two-year period, but in achieving the production targets, the entity
produces 20,000 units in some months and zero units in other months.
Despite the lag in manufacturing service, each unit comprises a series because ASC 606 does not require consecutive
performance of a service.
TRG DISCUSSIONS — SERIES GUIDANCE — ASSESSING ACCOUNTING OUTCOME
To apply the series guidance (that is, to account for multiple distinct goods or services comprising a series as a
single performance obligation), does the accounting result need to be the same as if the underlying distinct
goods or services each were accounted for as separate performance obligations?
No. The TRG discussed this issue in March 2015 and generally agreed that the series guidance does not include a
requirement to assess whether the accounting outcome of applying the series guidance would be the same as the
outcome of accounting for each distinct goods or services underlying the series as a separate performance
obligation.
The TRG stated that requiring entities to compare revenue recognition patterns in a “with and without” type
manner would be onerous and negate the FASB’s intent in establishing the series guidance, which was to simplify
the accounting and make it more operational. A requirement to prove whether application of the series guidance
results in a difference in the revenue recognition result would be counter to that objective. Therefore, the
application of the series guidance does not require an entity’s revenue recognition to be substantially the same with
or without the series provision.
BDO INSIGHTS — SERIES GUIDANCE IS MANDATORY IF APPLICABLE
Although the series guidance simplifies the application of ASC 606 in many situations, it is not a practical expedient
that entities have a choice of applying. Rather, it is mandatory if the criteria for its application are met. Therefore,
entities need to carefully consider whether the series guidance is applicable, in particular, to repetitive service
contracts or contracts involving the delivery of a quantity of similar items that are not all delivered at the same
REVENUE RECOGNITION UNDER ASC 606 74
time, but repeatedly over the contractual period. See Chapter 6 for discussion on the pattern of transfer of a
performance obligation.
Determining whether the series guidance is applicable requires the application of professional judgment, based on
the facts and circumstances.
EFFECT OF THE SERIES GUIDANCE ON OTHER ASPECTS OF ASC 606
There are three primary areas in which the accounting treatment may vary when a promise is a single performance
obligation comprised of a series of distinct goods or services, rather than a single performance obligation comprised
of goods or services that are not distinct from each other:
Changes in transaction price (see Section 4.8) — ASC 606 requirements are applied differently in some cases to
a single performance obligation comprised of non-distinct goods or services compared to a single performance
obligation resulting from applying the series guidance.
Allocation of variable consideration (see Section 5.5) — The amount of the variable consideration that is
recognized for each reporting period could be different, as the standard requires an entity to allocate variable
consideration solely to one or more distinct goods or services even if those goods or services form a single
performance obligation.
Contract modifications (see Section 7.3) — If the remaining undelivered goods or services are distinct (even if
part of a single performance obligation under the series guidance), the entity will account for the modified
contract on a prospective basis, whereas if the remaining goods or services are not distinct from those already
provided, there will be a cumulative effect adjustment resulting from the modification.
3.5 WARRANTIES
FASB REFERENCES
ASC 606-10-55-30 through 55-35
An entity may provide a warranty in connection with the sale of a good or service in accordance with the contract, the
law or the entity’s customary business practices. The nature of a warranty can vary significantly across industries and
contracts. ASC 606 differentiates between assurance- and service-type warranties:
A warranty that provides the customer with a service
in addition to the assurance that the product will
function in accordance with agreed-upon
specifications.
For example, a customer could purchase an extended
warranty that requires the original equipment
manufacturer to repair the equipment if it stops
working after the standard warranty period expires.
Service-type Warranty
A warranty that provides a customer with the
assurance that the product will function in
accordance with agreed-upon specifications.
For example, an equipment manufacturer may sell an
equipment with standard warranty to cover any
manufacturing defects for five years after purchase
of the equipment by the customer. These are
accounted for in accordance with the guidance on
product warranties in ASC 460.
Assurance-type Warranty
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If a customer can purchase a warranty separately (for example, because the warranty is priced or negotiated
separately), the warranty is a service-type warranty accounted for as a separate performance obligation. That
warranty represents a distinct service that the entity promises to provide to the customer in addition to the product
that has the functionality described in the contract.
Even if a warranty is not sold separately, an entity evaluates whether the warranty, or a part of the warranty, provides
the customer with a service in addition to an assurance that the product complies with agreed-upon specifications
(that is, an assurance component). In assessing whether a warranty provides a customer with a service in addition to
the assurance component, an entity considers factors such as:
,
If a warranty, or a part of the warranty, does not provide a customer with a service in addition to the assurance that a
product complies with agreed-upon specifications, then an entity must account for that warranty in accordance with
the guidance on product warranties in ASC 460-10 on guarantees. However, if a warranty, or a part of a warranty,
provides a customer with a service in addition to the assurance that the product complies with agreed-upon
specifications, the promised service represents a service-type warranty, which is a separate performance obligation
from the product. Therefore, an entity must allocate the transaction price to the product and the service-type
warranty (see Chapter 5 for discussion on allocation of transaction price). Further, if an entity promises both an
assurance-type warranty and a service-type warranty but cannot reasonably account for them separately, then the
entity must account for both warranties as a single performance obligation distinct from the related product.
A law that requires an entity to pay compensation if its products cause harm or damage does not create a performance
obligation. For example, if a laptop manufacturer sells laptops in a jurisdiction in which the law holds the laptop
manufacturer liable for any damages that might be caused by a consumer using a product for its intended purpose, the
legal requirements do not create a performance obligation. Similarly, an entity’s promise to indemnify the customer
for liabilities or damages arising from claims of patent, copyright, trademark, or other infringement by the entity’s
products does not create a separate performance obligation. Rather, an entity accounts for such obligations in
accordance with ASC 450-20, Contingencies ― Loss Contingencies.
EXAMPLE 3-17: LIFETIME WARRANTY
A manufacturer manufactures high-end, designer computer carrying cases. Each computer case comes with a
lifetime warranty on parts and labor. The warranty covers any type of damage to the case, no matter what the
cause.
Each contract likely includes both an assurance and service warranty because:
There is no local law requiring the manufacturer to provide lifetime warranty on the cases.
If an entity must perform specified tasks to provide the assurance that a product will function in accordance with
agreed-upon specifications (for example, a return shipping service for a defective product), then those tasks likely
do not give rise to a performance obligation.
Nature of the Tasks That the Entity Promises to Perform
A law requiring an entity to provide a warranty indicates that the warranty is not a performance obligation because
such requirements typically exist to protect customers from the risk of purchasing defective products.
Whether the Warranty Is Required by Law
A longer coverage period indicates that it is more likely that the promised warranty is a performance obligation
because an entity is more likely to provide a service in addition to the assurance that the product complies with
agreed-upon specifications.
Length of the Warranty Coverage Period
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The length of time covered by the warranty covers the life of the case.
The warranty covers damage beyond manufacturing defects.
The manufacturer devises an accounting policy, controls, and processes to:
Identify the implicit assurance warranty period, and the likely period over which customers will benefit from the
service warranty.
Determine the portion of the transaction price that is allocable to the service warranty.
Recognize the amount of revenue allocated to the service warranty over the anticipated period that customers
will benefit from the implied service warranty.
Revenue recognition for the service warranty begins at the end of the assurance warranty period, unless the
manufacturer concludes that it cannot reasonably separate the assurance warranty and the service warranty, in
which case revenue recognition commences when control of the computer case transfers to the customer. See
Chapter 6 for discussion on recognizing revenue when (or as) a performance obligation is satisfied.
TRG DISCUSSIONS — WARRANTIES
In March 2015, the TRG discussed a fact pattern that included a lifetime warranty similar to Example 3-17. In
discussing the fact pattern, the FASB staff considered the following two aspects of the guidance on warranties:
If an entity is required by law to provide a warranty, the existence of that law indicates that the promised
warranty is not a performance obligation.
A law that requires an entity to pay compensation if its products cause harm or damage does not give rise to a
performance obligation.
The FASB staff stated that the two aspects of the guidance on warranties must not be applied by analogy to
warranties that are not required by law and that such an analogy disregards the nature of the promise given to the
customer, the three factors in ASC 606 for determining whether a warranty is a performance obligation, and the
overall facts and circumstances of the arrangement.
The FASB staff stated that while not determinative in isolation, the length of the warranty is an important
consideration under ASC 606. Overall, an entity must not focus its assessment on when the fault in the product
arises. Rather, an entity must evaluate if the substance of the warranty reflects an additional service, considering
the promises made, and using the three factors in ASC 606 to assess whether the warranty is a performance
obligation.
An evaluation of whether a warranty provides a service in addition to the assurance that the product complies with
agreed-upon specifications requires judgment and consideration of the facts and circumstances.
BDO INSIGHTS — WARRANTIES
An entity determines the amount of transaction price to be allocated to a separately priced extended warranty
contract using a standalone selling price methodology, rather than simply using the contractually stated price (see
Section 7.6.1 for a related discussion). Additionally, regardless of whether a warranty is separately priced, an entity
determines whether a portion of the warranty represents a service warranty that must be accounted for separately.
Reaching a conclusion about whether an entity is providing a service warranty, and if so, measuring the standalone
selling price of that service warranty may require the application of professional judgment, based on the facts and
circumstances.
Additionally, entities accrue the costs related to assurance warranties under ASC 460.
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3.6 PRACTICAL EXPEDIENT FOR NONPUBLIC FRANCHISORS
FASB REFERENCES
ASC 952-606-25-2 through 25-4
ASC 952-606-20
A franchisor is defined as “the party who grants business rights (the franchise) to the party (the franchisee) who
will operate the franchised business.”
During the implementation of ASC 606, private entity stakeholders in the franchise industry raised concerns about the
cost and complexity of identifying performance obligations related to pre-opening services provided in a franchise
agreement and determining the amount and timing of revenue recognition for initial franchise fees. The initial
franchise fee is an upfront payment typically paid in a lump sum to a franchisor in exchange for establishing a franchise
relationship, with the provision of varying levels of pre-opening services to the franchisee.
Under the prior industry-specific guidance in ASC 952, Franchisors, the initial franchise fee was recognized when the
franchisor delivered the promised pre-opening services, which was typically when the franchise location opened. Under
the five-step revenue recognition model in ASC 606, the franchisor must determine whether the pre-opening activities
represent distinct performance obligations and, if so, evaluate the standalone selling prices for those performance
obligations to determine the timing and amount of revenue recognition.
The FASB issued ASU 2021-02 to provide nonpublic franchisors with a practical expedient to account for certain pre-
opening services as distinct from the franchise licenses when identifying performance obligations under ASC 606. The
practical expedient simplifies the evaluation of whether pre-opening activities are distinct from the related franchise
right. Application of this guidance directly or by analogy is prohibited for all other entities.
As a practical expedient, a nonpublic franchisor may account for the following pre-opening services as distinct from the
promise to grant the franchise license:
Assistance in the selection of a site
Assistance in obtaining and preparing the facilities for their intended use, including related financing, architectural,
engineering and lease negotiation services
Training of the franchisee’s personnel or the franchisee
Preparation and distribution of manuals and similar material about operations, administration and record keeping
Bookkeeping, IT, advisory services, including setting up the franchisee’s records and advising the franchisee about
income, real estate, and other taxes or about regulations affecting the franchisee’s business
Inspection, testing, and other quality control programs
A franchisor that elects to use the practical expedient may elect an accounting policy to account for the bundle of pre-
opening services as a single performance obligation, instead of evaluating whether each of the pre-opening services is
distinct.
If a franchisor elects not to apply the practical expedient or the pre-opening services in the arrangement do not qualify
for the practical expedient, the franchisor applies the general guidance on identifying performance obligations (see
discussion in Sections 3.2 through 3.5).
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BDO INSIGHTS — PRACTICAL EXPEDIENT FOR NONPUBLIC FRANCHISORS MUST BE APPLIED CONSISTENTLY
If elected, the practical expedient for nonpublic franchisors must be applied consistently to contracts with similar
characteristics and in similar circumstances.
Since the expedient is only intended to simplify the application of Step 2 of the model, franchisors must apply the
general guidance in ASC 606 for the remaining aspects of accounting for revenue, including allocating the
transaction price and recognizing revenue. Specifically, there is no relief from determining the standalone selling
price of the pre-opening services that are considered distinct. This assessment requires the application of
professional judgment, based on the facts and circumstances. A franchisor cannot assume that the standalone
selling price of the pre-opening services is equal to the amount of the initial franchise fee.
Additionally, although a franchisor can account for the distinct pre-opening services as a bundle, the determination
of the standalone selling price for the bundle may not be easier than the determination for each of the services
separately.
BE CAREFUL BEFORE ELECTING AN EXPEDIENT FOR A NONPUBLIC ENTITY
There is no transition relief if a nonpublic entity becomes a public business entity (as defined in U.S. GAAP).
Therefore, the entity accounts for such a change in accordance with ASC 250, Accounting Changes and Error
Corrections, and restates its financial statements without applying the nonpublic entity practical expedient, which
can be complex and time consuming. An entity should carefully consider the likelihood of becoming a public
business entity (including acquisition by an existing public business entity) before electing this alternative.
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CHAPTER 4 — STEP 3: DETERMINE
THE TRANSACTION PRICE
4.1 OVERVIEW
After identifying the performance obligations in a contract in Step 2, an entity determines the transaction price for the
contract. Determining the transaction price is a key step in the five-step revenue recognition model because the
transaction price is the amount that an entity allocates to the performance obligations in a contract and ultimately
recognizes as revenue when (or as) the performance obligations are satisfied.
The transaction price is the amount of consideration to which an entity expects to be entitled in exchange for
transferring goods or services to a customer. Consequently, the objective in determining the transaction price is to
ascertain the total amount of consideration to which the entity will be entitled from the contract. The transaction
price is often the amount specified in the contract. However, determining the transaction price is more challenging if
the contracts include variable consideration. ASC 606 requires an entity to estimate variable consideration initially at
contract inception and to update that estimate at the end of each reporting period. The estimated amount of variable
consideration is included in the transaction price only to the extent that it is probable that a significant reversal of
cumulative revenue recognized will not occur when the uncertainty from the variable consideration is subsequently
resolved. Additionally, in determining the transaction price for a contract, an entity is required to consider the
contractual terms, the effect of customary business practices that may indicate that the entity will accept a lower
amount than stated in the contract, noncash consideration, consideration payable to customer and any significant
financing component.
The following diagram illustrates the key concepts in determining the transaction price in Step 3:
Fixed
Consideration
Variable
Consideration
OR
Significant
Financing
Component
Noncash
consideration
Consideration
Payable to a
Customer
Transaction
Price
Presentation
and
Disclosures
Scope
Step 1:
Identify the
contract
with a
customer
Step 2:
Identify the
performance
obligations in
the contract
Step 3:
Determine
the
transaction
price
Step 4:
Allocate the
transaction price to
the performance
obligations
Step 5:
Recognize revenue
when or as the
performance
obligation is
satisfied
Other
Topics
REVENUE RECOGNITION UNDER ASC 606 80
BDO INSIGHTS ― ESTIMATING VARIABLE CONSIDERATION
ASC 606 requires entities to estimate variable consideration with limited exceptions. While estimating revenue
reflects the principle in ASC 606 that the amount recognized in revenue closely depicts the transfer of control, it
introduces uncertainty in the measurement of revenue. Estimating variable consideration requires the application of
professional judgment, based on the facts and circumstances.
4.2 DETERMINING THE TRANSACTION PRICE
FASB REFERENCES
ASC 606-10-32-2 through 32-4
The transaction price is the amount of consideration to which an entity expects to be entitled in exchange for
transferring promised goods or services to a customer. The consideration promised in a contract with a customer may
include fixed amounts, variable amounts, or consideration in a form other than cash. An entity considers the terms of
the contract and its customary business practices to determine the transaction price.
The nature, timing, and amount of consideration promised by a customer affect the estimate of the transaction price
and, therefore, an entity must consider the effects of all of the following in addition to the fixed consideration in the
contract:
Variable consideration
Constraining estimates of variable consideration
The existence of a significant financing component in the contract
Noncash consideration, that is, an amount of consideration in a form other than cash
Consideration payable to a customer by the entity
Although determining the transaction price requires several estimates about the future, the estimates are based on the
goods and services to be transferred in accordance with the existing contract. Expectations about whether the contract
will be cancelled, renewed, or modified are not considered when estimating the transaction price.
BC186 of ASU 2014-09 clarifies that the transaction price includes only amounts (including variable amounts) to which
an entity has rights under the present contract. For example, the transaction price does not include an entity’s
estimates of consideration received from the future exercise of customer options for additional goods or services or
from future change orders because until the customer exercises the option or agrees to the change order, the entity
does not have a right to the related consideration.
In BC187 of ASU 2014-09, the FASB clarified that the amounts to which the entity has rights under the present contract
can be paid by any party (that is, not only by the customer). For example, in the healthcare industry, an entity may
determine the transaction price based on amounts to which it will be entitled to payment from the patient, insurance
entities, or governmental organizations. This may also occur in other industries, for example, when an entity receives a
payment from a manufacturer because the manufacturer issues coupons or rebates directly to the entity’s customer or
when an entity acts as an agent on behalf of another entity but collects the consideration from the end consumer (see
Section 7.2 for discussion on principal versus agent assessment).
Amounts collected on behalf of another party (for example, some sales taxes) are not included in the transaction price.
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4.2.1 Accounting Policy Election for Taxes
An entity may make an accounting policy election to exclude from the measurement of transaction price all taxes
assessed by a taxing authority related to the specific transaction that are collected from the customer. Examples
include sales, use, value added and some excise taxes. If an entity elects the policy, such tax amounts are presented
net, that is, as reductions of the transaction price (or revenue) rather than as costs in the income statement. If an
entity does not elect the policy, it must analyze each jurisdiction in which it operates to determine whether such
amounts are included in or excluded from the transaction price.
4.3 VARIABLE CONSIDERATION
The following diagram provides an overview of the accounting considerations for variable consideration:
Constrain the Estimate to an Amount for Which it is Probable That There Will Not be a
Significant Reversal of Cumulative Revenue Recognized When the Uncertainty is Resolved
Identify Variable Consideration
Estimate the Variable
Consideration*
Apply the Variable Consideration
Constraint
Include the Estimated and
Constrained Variable Consideration in
the Transaction Price
Determine the Appropriate Method to
Estimate the Variable Consideration
Reassess the Estimated and
Constrained Variable Consideration at
Each Reporting Date
*See Section 4.3.2 for the limited exceptions from estimating variable consideration.
REVENUE RECOGNITION UNDER ASC 606 82
4.3.1 Identifying Variable Consideration
FASB REFERENCES
ASC 606-10-32-5 through 32-7, ASC 606-10-55-194 and 55-195
Variable consideration can arise in any circumstance in which the amount of consideration to which the entity is
entitled varies. An entity is required to estimate the amount of consideration to which it expects to be entitled in
exchange for transferring the promised goods or services to a customer. Examples of common types of variable
consideration that may exist in a contract with a customer include:
Discounts
Incentives
Rebates
Performance bonuses
Refunds
Penalties
Credits
Other similar items
Price concessions
Sales-or usage-based royalties
The consideration for a contract can vary if an entity’s entitlement to the consideration is contingent on the
occurrence or nonoccurrence of a future event. For example, an amount of consideration is variable if a good is sold
with a right of return or a fixed amount is promised as a performance bonus upon achievement of a specified
milestone.
BC191 of ASU 2014-09 includes an example of a fixed-price service contract in which the customer pays upfront, and
the terms of the contract provide the customer with a full refund of the amount paid if the customer is dissatisfied
with the service at any time. In that example, the consideration is variable because the entity might be entitled to all
of the consideration or none of the consideration if the customer exercises its right to a refund.
See Section 7.4.1.1 for a summary of the TRG discussions on whether a variable quantity of a good or service
constitutes a customer’s purchase option(s) or variable consideration.
4.3.1.1 Implied Variable Consideration
Variability in consideration may be explicitly stated in a contract or implied based on an entity’s customary business
practices or other facts and circumstances surrounding the contract. That is, an entity must look beyond the contract
between an entity and its customer to identify all forms of variable consideration. Variable consideration may be
implied if either of the following conditions are met:
Customary Business Practices ― The customer has a valid expectation arising from an entity’s customary business
practices, published policies, or specific statements that the entity will accept an amount of consideration that is
less than the contractually stated price. That is, the customer expects that the entity will offer a price concession.
Based on the jurisdiction, industry or customer, this offer (or price concession) may be referred to as a discount,
rebate, refund or credit.
• In BC192 of ASU 2014-09, the FASB stated that in many cases, entities grant price concessions to enhance
customer relationships or to encourage future sales to customers. For example, a manufacturing entity may grant
a price concession to a retailer customer for goods that were previously sold to that retailer to enable the
retailer to discount the goods and, therefore, more easily sell them to a third-party end consumer.
Other Facts and Circumstances ― Other facts and circumstances indicate that the entity’s intention, when entering
the contract with the customer, is to offer a price concession to the customer by accepting a lower amount of
consideration than contractually stated.
• BC193 of ASU 2014-09 includes an example in which an entity enters a contract with a new customer with a
strategy to develop the customer relationship. In that case, although there may not be past evidence that the
REVENUE RECOGNITION UNDER ASC 606 83
entity will provide a price concession in future, there may be other factors that result in the entity concluding
that it will accept a lower price than contractually stated.
EXAMPLE 4-1 (ADAPTED FROM ASC 606-10-55-194 AND 55-195): VARIABLE CONSIDERATION — PENALTY
A construction entity enters a contract with a customer to build an asset for $2 million. The terms of the contract
include a penalty of $200,000 if the construction is not completed within four months of a date specified in the
contract. The construction entity concludes that the consideration promised in the contract includes a fixed amount
of $1.8 million and a variable amount of $200,000 arising from the penalty.
BDO INSIGHTS — PRICE CONCESSION VERSUS CREDIT RISK
Sometimes it may be difficult to determine whether an entity has offered a price concession or has chosen to
accept the risk of the customer defaulting on the contractually agreed amount of consideration. In the development
of ASC 606, the FASB stated that this judgment was already required in the prior revenue recognition guidance and
decided not to include detailed requirements in ASC 606 for making the distinction between a price concession and
an impairment of receivables.
When a customer does not pay the contractually stated amount, an entity must consider whether it is providing a
price concession or has incurred bad debt expense. We believe if the entity continues to provide goods or services
to the customer despite not collecting the contractually stated price related to prior performance, the entity may
have offered a price concession. However, this determination requires the application of significant judgment,
based on the facts and circumstances.
4.3.2 Estimating Variable Consideration
FASB REFERENCES
ASC 606-10-32-8 through 32-9, ASC 606-10-55-197 through 55-199
When the consideration promised in a contract with a customer includes a variable amount, an entity estimates the
amount of variable consideration it expects to be entitled to in exchange for promised goods or services in the contract
by using either of the following two methods:
The expected value — The sum of probability-weighted amounts in a range of possible consideration amounts. It
may be an appropriate estimate of the variable consideration if a contract includes a large number of possible
outcomes or if an entity has many contracts with similar characteristics.
The most likely amount — The single most likely amount in a range of possible consideration amounts (that is, the
single most likely outcome of the contract). It may be an appropriate estimate of the variable consideration if the
contract has only two possible outcomes (for example, an entity either achieves a performance bonus or does not).
SELECT A METHOD TO ESTIMATE VARIABLE CONSIDERATION
Selecting a method to estimate a variable consideration is not intended to be a free choice; rather, an entity must
determine which method it expects to better predict the amount of consideration to which it will be entitled and
apply that method consistently for similar types of contracts.
REVENUE RECOGNITION UNDER ASC 606 84
The expected value method (that is, the probability-weighted method) reflects all the uncertainties existing in the
transaction price at the end of the reporting period and, therefore, best reflects the conditions that are present at the
end of each reporting period. For instance, it reflects the possibility of receiving a greater amount of consideration as
well as the risk of receiving a lesser amount. The expected value method could be used to predict the amount of
consideration to which an entity will be entitled if the entity has many contracts with similar characteristics.
However, an expected value may not always faithfully predict the consideration to which an entity will be entitled.
BC200 of ASU 2014-09 includes an example in which an entity is certain to receive one of the only two possible
consideration amounts in a single contract. In those cases, the expected value would not be a possible outcome and,
therefore, might not be relevant in predicting the amount of consideration to which the entity will be entitled. Rather,
the most likely amount method identifies the individual amount of consideration in the range of possible consideration
amounts that is more likely to occur than any other individual outcome.
Although an entity using the most likely amount method must consider all possible outcomes to identify the most likely
one, in practice, the entity is not required to quantify the less probable outcomes. Similarly, in practice, estimating
variable consideration under the expected value method (that is, probability-weighted method) does not require an
entity to consider all possible outcomes using complex models and techniques even if an entity has extensive data and
can identify many outcomes. In many cases, a limited number of discrete outcomes and probabilities can often provide
a reasonable estimate of the distribution of possible outcomes for variable consideration in a contract.
INFORMATION CONSIDERED IN ESTIMATING A VARIABLE CONSIDERATION
An entity must consider all the information (historical, current, and forecast) that is reasonably available to the
entity to identify a reasonable number of possible amounts of variable consideration. Typically, that information
would be similar to the information that the entity’s management used during the bid-and-proposal process and
when it established prices for the promised goods or services.
CONSISTENT APPLICATION OF THE METHOD SELECTED TO ESTIMATE AN UNCERTAINTY
An entity applies one method consistently throughout the contract when estimating the effect of an uncertainty on
an amount of variable consideration to which the entity expects to be entitled.
However, this does not mean that an entity would need to use one method to measure each uncertainty in a single
contract. Rather, an entity may use different methods for different uncertainties in a single contract.
EXAMPLE 4-2 (ADAPTED FROM ASC 606-10-55-197 THROUGH 55-199): VARIABLE CONSIDERATION — METHODS
OF ESTIMATION
A construction entity enters a contract with a customer to build a customized asset. The contract includes the
following terms related to pricing:
The promised consideration is $4 million.
For each day after a specified date that the asset is incomplete, the promised consideration decreases by
$20,000.
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For each day before that specified date that the asset is complete, the promised consideration increases by
$20,000.
Upon completion of the asset, if the asset receives a specified rating from a third-party inspector based on
certain contractually defined metrics, the construction entity will be entitled to a bonus of $300,000.
In determining the transaction price, the construction entity identifies two types of variable consideration in the
contract:
Variable consideration from the daily penalty or incentive for an amount of $20,000
Variable consideration from the bonus for an amount of $300,000
The construction entity concludes the following regarding the appropriate method of estimating the two types of
variable consideration in the contract:
The expected value method is appropriate for estimating the variable consideration from the daily penalty or
incentive (that is, $4 million, plus or minus $20,000 per day). The entity expects that method to better predict
the amount of consideration to which it will be entitled because there is a range of possible outcomes dependent
on how the variability is resolved.
The most likely amount method is appropriate for estimating the variable consideration from the bonus because
there are only two possible outcomes ($300,000 or $0). The entity expects the most likely amount method will
better predict the amount of consideration to which it will be entitled because the outcome is binary, and a
probability-weighted amount will not reflect either of the possible outcomes.
BDO INSIGHTS — LIMITED EXCEPTIONS FROM ESTIMATING VARIABLE CONSIDERATION
While ASC 606 generally requires entities to estimate all variable consideration, there are a few exceptions:
An entity does not estimate variable consideration if the variable consideration in the form of sales- or usage-
based royalties in exchange for licenses of IP (in accordance with ASC 606-10-55-64 through 55-65B). This
exception is explicitly limited to licenses of IP and cannot be applied to sales- or usage-based royalties in
exchange for providing other goods or services, including SaaS. See Section 7.5.4 for related discussion.
An entity does not estimate variable consideration if it applies the as-invoiced practical expedient to recognize
revenue in accordance with ASC 606-10-55-18. See Section 6.4.2.1.1 for related discussion.
An entity does not estimate variable consideration if the variable consideration allocation exception in ASC 606-
10-32-40 applies (see Section 5.5) as follows:
• A performance obligation will be satisfied in future and the variable consideration is allocated entirely to that
performance obligation.
• A series of distinct services is determined to be a series of distinct time increments and the variable
consideration relates to the distinct services provided in the period in which it is earned.
Reaching a conclusion on whether any of the exceptions from estimating variable consideration is applicable
requires the application of professional judgment, based on the facts and circumstances.
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Constrain the Estimate to an Amount for Which it is Probable That There Will NOT be a
Significant Reversal of Cumulative Revenue Recognized When the Uncertainty is Resolved
4.3.3 Constraining Estimates of Variable Consideration
FASB REFERENCES
ASC 606-10-32-11 and 32-12
Estimating the amount of variable consideration introduces uncertainty to the measurement of revenue. To reduce the
possibility that variable consideration recognized in one reporting period is reversed in a subsequent period, the
inclusion of an estimated amount of variable consideration in the transaction price is limited to the amount for which it
is probable that there will not be a significant reversal of cumulative revenue recognized when the uncertainty from
the variable consideration is subsequently resolved. This is known as the “variable consideration constraint.” The
variable consideration constraint restricts revenue recognition by using measurement uncertainty as the basis for
determining if (or how much) revenue to recognize.
The term “probable” is widely used and understood in practice and is defined in U.S. GAAP as “the future event or
events are likely to occur” (ASC 450, Contingencies).
In assessing whether it is probable that a significant reversal of cumulative revenue recognized will not occur once the
uncertainty related to the variable consideration is subsequently resolved, an entity evaluates both:
The likelihood of a revenue reversal
The magnitude of the revenue reversal
ASSESSING THE PROBABILITY OF A SIGNIFICANT REVERSAL OF CUMULATIVE REVENUE RECOGNIZED
An entity must consider all facts and circumstances and use significant judgment when assessing the probability of a
significant reversal of cumulative revenue recognized. Factors that may increase the likelihood or the magnitude of
a revenue reversal include, but are not limited to, the following:
The consideration is highly susceptible to factors outside the entity’s influence, including:
• Volatility in a market
• The judgment or actions of third parties (for example, when the amount of variable consideration varies
based on the customer’s subsequent sales)
• Weather conditions
• A high risk of obsolescence of the promised good or service
Uncertainty regarding the amount of variable consideration is not expected to be resolved for a long period of
time.
Estimate the Variable Consideration
Apply the Variable Consideration
Constraint
REVENUE RECOGNITION UNDER ASC 606 87
The entity’s experience (or other evidence) with similar types of contracts is either limited or has limited
predictive value.
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.
The contract has many possible variable consideration amounts.
In BC212 of ASU 2014-09, the FASB stated that the analysis an entity would undertake to determine the likelihood of
whether a significant revenue reversal could occur would still be largely qualitative, and it did not expect an entity to
prepare a quantitative analysis each time it performed that analysis.
In developing the variable consideration constraint guidance, the FASB’s intention was not to eliminate the use of
estimates, which are common and necessary in financial reporting, but rather to make sure that those estimates are
robust and result in useful information.
The FASB decided to focus the variable consideration constraint on possible downward adjustments (that is, revenue
reversals), rather than on all revenue adjustments (that is, both downward and upward adjustments), because users of
financial statements indicated that revenue is more relevant if it is not expected to be subject to significant future
reversals.
BDO INSIGHTS — CONSTRAINING ESTIMATES OF VARIABLE CONSIDERATION
When variable consideration has a wide range of potential outcomes (for example, from zero to $100,000 depending
on number of website visits), it is unlikely that the transaction price will be constrained to zero, because that
outcome would be highly unlikely.
Additionally, when an entity applies the portfolio practical expedient to multiple similar contracts or performance
obligations, it would be rare for variable consideration included in the transaction price to be fully constrained,
because that would require an assumption that the outcome of every instance of uncertainty would be zero.
Regardless of whether an entity elects to use the portfolio practical expedient, we believe that an entity must
consider its past experience with similar contracts with similar customers when determining the amount of variable
consideration to be included in the transaction price, unless the experience with those past contracts is not
reflective of the expected outcome of the current contract, which would be unusual.
The constraint may reduce the amount of variable consideration included in the transaction price to zero when the
outcome is binary (for example, zero or $100,000 bonus based on the achievement of a performance milestone),
and significant uncertainty exists relating to the outcome.
In addition, in some instances the requirement to limit the estimated variable consideration to an amount that is
not probable of being reversed could result in recognizing revenue in an amount that is less than an entity’s best
estimate. See Example 4-4 for an illustration.
Reaching a conclusion on whether and how much to constrain the estimate of variable considerations requires the
application of professional judgment, based on the facts and circumstances.
TRG DISCUSSIONS — VARIABLE CONSIDERATION AND CONSTRAINING ESTIMATE — IS THE CONSTRAINT
APPLIED AT THE CONTRACT OR PERFORMANCE OBLIGATION LEVEL?
Some contracts that include more than one performance obligation have both fixed and variable consideration. The
TRG considered whether the requirement to constrain the recognition of any variable consideration should apply at
the contract level or performance obligation level when the variable consideration has not been allocated
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proportionately to all performance obligations in a contract. See Chapter 5 for discussion on allocation of
consideration to performance obligations.
In January 2015, the TRG generally agreed that the constraint on variable consideration is applied at the contract
level and not at the performance obligation level. This is because the unit of account for determining the
transaction price in Step 3 is the contract.
TRG DISCUSSIONS — PORTFOLIO PRACTICAL EXPEDIENT AND APPLICATION OF VARIABLE CONSIDERATION
CONSTRAINT
In July 2015, the TRG discussed the application of the optional portfolio approach practical expedient (see
Section 1.6 for related discussion) that allows entities to apply ASC 606 to a portfolio of contracts with similar
characteristics instead of individual contracts. TRG members agreed that estimating the transaction price using the
evidence obtained from other similar contracts (‘portfolio of data’) is different from applying the portfolio practical
expedient.
One example of the practical effect of this distinction could be when an entity is developing an estimate of variable
consideration for a single contract using the expected value method. The TRG conclusion means that the entity is
not necessarily applying the portfolio practical expedient when considering historical data for other similar
contracts. Therefore, there is no need to comply with the restriction on the use of the portfolio practical
expedient, which is to conclude that there is a reasonable expectation that the effects on the financial statements
from applying the guidance to a portfolio of contracts would not differ materially from applying the guidance to
individual contracts within the portfolio.
The TRG also discussed the application of the variable consideration constraint, which limits revenue recognition to
the amount for which it is probable that there will not be a significant reversal of revenue previously recognized
when the uncertainty over the amount of revenue is resolved. TRG members discussed whether ASC 606 requires
applying the constraint to a portfolio of contracts when a portfolio of data was used to estimate variable
consideration or whether the constraint can be applied at an individual contract level. The TRG concluded that the
approach followed is linked to whether the entity concludes that it should use the expected value approach or the
most likely amount method when it estimates the transaction price. If an entity uses the expected value approach,
then it would be consistent and appropriate to use the portfolio of data to estimate variable consideration. If the
most likely amount method is followed, then a portfolio approach should not be used.
4.3.4 Is Estimating Variable Consideration and Applying the Constraint a Two-Step Process?
FASB REFERENCES
ASC 606-10-32-8 and ASC 606-10-32-11
The variable consideration constraint guidance first requires an entity to estimate the consideration to which the
entity will be entitled. The entity then assesses whether the objective of the variable consideration constraint
guidance can be met — that is, by determining whether it is probable that a significant revenue reversal will not occur
when the uncertainty from the variable consideration is subsequently resolved. If the entity determines that it is
probable that the inclusion of its estimate will not result in a significant revenue reversal, that amount is included in
the transaction price.
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In BC215 of ASU 2014-09, the FASB stated that an entity would not be required to strictly follow those two steps if the
entity’s process for estimating variable consideration already incorporates the principles on which the guidance for
constraining estimates of variable consideration is based. For example, an entity might estimate revenue from sales of
goods with a right of return; a sale with a right of return creates variability in the transaction price — see Section 4.3.8
for related discussion. In that case, the entity might not practically need to estimate the expected revenue and then
apply the constraint guidance to that estimate in a two-step process, if the entity’s calculation of the estimated
revenue incorporates the entity’s expectations of returns at a level at which it is probable that the cumulative amount
of revenue recognized would not result in a significant revenue reversal.
4.3.5 Sales-Based or Usage-Based Royalty for Licenses of IP
ASC 606 includes an exception from estimating and constraining variable consideration for variable consideration in the
form of a sales-based or usage-based royalty that is promised in exchange for a license of IP. See Section 7.7 for
discussion on licenses of IP and the exception from estimating variable consideration.
4.3.6 Reassessment of Variable Consideration
FASB REFERENCES
ASC 606-10-32-14
An entity must update the estimated transaction price (including its assessment of whether an estimate of variable
consideration is constrained) at the end of each reporting period to represent faithfully the circumstances present at
the end of the reporting period and the changes in circumstances during the reporting period. The estimated amount of
variable consideration may change at each reporting date as more information becomes available and there is greater
certainty about the expected amount of consideration. See Section 4.8 for discussion on accounting for changes in the
transaction price.
EXAMPLE 4-3 (ADAPTED FROM ASC 606-10-55-208 THROUGH 55-212): PRICE CONCESSIONS — ESTIMATE OF
VARIABLE CONSIDERATION IS NOT CONSTRAINED
An entity enters a contract with a customer, a retailer, on December 1, 20X1. The entity transfers 10,000 products
at contract inception. Following are the pricing terms:
The contractually stated price per product is $20. That is, the total contractually stated price is $200,000.
The customer is obligated to make payments when the customer sells the products to the end customers.
The entity has past experience that the customer generally sells the products within 60 days of receiving them.
Based on its past practices and to maintain its customer relationship, the entity anticipates granting a price
concession to its customer to enable the customer to discount the product and move it quickly through the
distribution chain. Therefore, the entity determines that the consideration in the contract is variable even though
the contract stipulates a fixed price.
The entity considers the following:
It has significant experience selling this and similar products.
The observable historical data indicates that the entity grants an average price concession of 25% of the sales
price for these products.
Current market information indicates that a 25% price concession will be sufficient to quickly move the products
through the distribution chain
The entity has not granted a price concession significantly greater than 25% in many years.
The entity decides to use the expected value method to estimate the variable consideration because the entity
expects that method to better predict the amount of consideration to which it will be entitled. This is because
REVENUE RECOGNITION UNDER ASC 606 90
there is a range of possible outcomes for how the variability in pricing will be resolved. The entity estimates the
transaction price to be $150,000 ($15 × 10,000 products) under the expected value method.
The entity considers the following to determine whether the estimated amount of variable consideration of
$150,000 can be included in the transaction price or must be constrained:
It has significant previous experience with this product and current market information that supports its
estimate.
Despite some uncertainty resulting from factors outside its influence, the entity expects the price to be resolved
within a short time frame based on its current market estimates.
Therefore, the entity concludes that it is probable that a significant reversal in the cumulative amount of revenue
recognized (that is, $150,000) will not occur when the uncertainty regarding the total amount of price concessions
is resolved. Consequently, the entity includes $150,000 in the transaction price, recognizes revenue of $150,000
when the products are transferred on December 1, 20X1 (see Chapter 6 for discussion on Step 5 on recognizing
revenue) and reassesses the estimates of the transaction price at each reporting date until the uncertainty is
resolved.
EXAMPLE 4-4 (ADAPTED FROM ASC 606-10-55-208 THROUGH 55-215): PRICE CONCESSIONS — ESTIMATE OF
VARIABLE CONSIDERATION IS CONSTRAINED
Consider the same fact pattern as in Example 4-3, with the following differences:
While the entity has experience selling similar products:
• The products have a high risk of obsolescence.
• The entity is experiencing high volatility in the pricing of its products.
The observable historical data indicates that the entity grants a broad range of price concessions ranging from
20% to 60% of the sales price for similar products.
Current market information also suggests that a 15% to 50% reduction in price may be necessary to move the
products through the distribution chain.
The entity decides to use the expected value method for the same reasons stated in Example 4-3. The entity
estimates that a discount of 40% will be provided. Therefore, the estimated variable consideration is $1200,000
($12 × 10,000 products).
The entity considers the following to determine whether the estimated amount of variable consideration of
$120,000 can be included in the transaction price or must be constrained:
The amount of consideration is highly susceptible to factors outside the entity’s influence because of the risk of
obsolescence.
It is likely that the entity will be required to provide a broad range of price concessions to move the products
quickly through the distribution chain.
As a result, the entity cannot conclude that it is probable that a significant reversal of cumulative revenue
recognized will not occur if $120,000 (that is, 40% discount on the sale price) is included in the transaction price.
Therefore, the entity cannot include its estimate of $120,000 in the transaction price. The entity considers the
following:
While the entity’s historical price concessions have ranged from 20% to 60%, current market information suggests
that a price concession of 15% to 50% will be necessary.
An analysis shows that its actual results have been consistent with then-current market information in previous,
similar transactions.
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Consequently, the entity concludes that it is probable that a significant reversal in the cumulative amount of
revenue recognized will not occur if the entity includes $100,000 in the transaction price (that is, 50% discount on
the sale price). Therefore, the entity includes $100,000 in the transaction price, recognizes revenue of $100,000
when the products are transferred on December 1, 20X1 (see Chapter 6 for discussion on Step 5 on recognizing
revenue), and reassesses the estimates of the transaction price at each reporting date until the uncertainty is
resolved.
BDO INSIGHTS — CONSTRAINING ESTIMATES OF VARIABLE CONSIDERATION IN EXAMPLE 4-4
In Example 4-4, although the amount of revenue recognized when the products were transferred to the retailer was
restricted due to the identified uncertainties, there was sufficient evidence to support the immediate recognition
of a portion of the estimated transaction price. For entities in the early stages of their operations, particularly
those operating in relatively new sectors, it is possible that application of the constraint will result in little, or no
revenue being recognized on the date on which control over goods or services transfers to customers, with revenue
recognition being postponed until a later date. However, in those circumstances, the inventory transferred to
customers would be derecognized with an associated cost of sales at the point at which control passes to the
customers. The estimate of variable consideration and appropriate constraint would then be reassessed at each
reporting date, with a corresponding amount of revenue being recognized as appropriate in each period.
EXAMPLE 4-5 (ADAPTED FROM ASC 606-10-55-216 THROUGH 55-220): VOLUME DISCOUNT INCENTIVE —
RETROSPECTIVE REDUCTION
An entity enters a contract with a customer on January 1, 20X1, to sell a product for $10 per unit. The price per
unit is retrospectively reduced to $9 per unit, if the customer purchases more than 10,000 units of the product in a
calendar year.
The entity determines that the consideration in the contract is variable because of the retrospective reduction in
price per unit of the products sold to the customer.
Constraining Estimates of Variable Consideration
The entity sells 100 units of the product to the customer in the first quarter ended March 31, 20X1. On that date,
the entity estimates that the customer’s purchases will not exceed the 10,000-unit threshold required for the
volume discount in the calendar year. The entity considers that it has significant experience with this product and
the purchasing pattern of the customer. Thus, the entity concludes that it is probable that a significant reversal in
the cumulative amount of revenue recognized (that is, $10 per unit) will not occur when the uncertainty regarding
the total number of products purchased in that calendar year is resolved.
Therefore, the entity recognizes revenue of $1,000 (100 units × $10 per unit) for the quarter ended March 31, 20X1.
Reassessment of Variable Consideration
In April 20X1, the entity’s customer acquires another entity and in the second quarter ended June 30, 20X1,
purchases an additional 5,000 products. Considering the new fact, the entity estimates that the customer’s
purchases will exceed the 10,000-unit threshold for the calendar year and, therefore, it will be required to
retrospectively reduce the price per unit to $9.
Therefore, the entity updates its transaction price (and cumulative revenue recognized) to $45,900 (5,100 units × $9
per unit) to reflect the reduced price per unit of $9 for the sale of 5,100 units.
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The entity recognizes $44,900 in the quarter ended June 30, 20X1. The amount is calculated as $45,000 for the sale
of the 5,000 units (5,000 units x $9 per unit) less the change in transaction price of $100 (100 units x $1 price
reduction per unit). See Section 4.8 for a discussion of changes in the transaction price.
EXAMPLE 4-6 (ADAPTED FROM ASC 606-10-55-221 THROUGH 55-225): MANAGEMENT FEES SUBJECT TO THE
CONSTRAINT
An entity enters a contract with a customer to provide asset management services for four years in exchange for:
A 2.5% quarterly management fee based on the customer’s assets under management at the end of each quarter
A performance-based incentive fee of 18% of the fund’s return in excess of the return of an observable market
index over the past four-year period.
The entity determines that both the management fee and the performance fee are variable consideration in the
contract.
At contract inception, the entity observes that:
The promised consideration in the contract is dependent on the market and, thus, is highly susceptible to factors
outside the entity’s influence.
The incentive fee has many possible consideration amounts.
Although it has experience with similar contracts, that experience is of little predictive value in determining the
future performance of the market.
Therefore, at contract inception, the entity determines that it cannot conclude that it is probable that a significant
reversal in the cumulative amount of revenue recognized would not occur if the entity included its estimate of the
management fee or the incentive fee in the transaction price.
At each reporting date, the entity updates its estimate of the transaction price and concludes that:
It can include the actual amount of the quarterly management fee in the transaction price because the
uncertainty related to the market is resolved.
It cannot include its estimate of the incentive fee for future periods in the transaction price at those dates
because there has been no change in its assessment of the likelihood of significant revenue reversal since
contract inception. That is, the variability of the fee based on the market index indicates that the entity cannot
conclude that it is probable that a significant reversal in the cumulative amount of revenue recognized would not
occur if the entity included its estimate of the incentive fee in the transaction price.
Note that the entity recognizes the quarterly management fee at the end of each quarter to which the fee relates
(rather than over the four-year term). This is because the quarterly management fee relates to the distinct services
provided during the corresponding quarter and the requirements in ASC 606-10-32-40 regarding an exception in
allocating variable consideration are met — see Section 5.5 for discussion on that guidance.
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4.3.7 Refund Liability
FASB REFERENCES
ASC 606-10-32-10
An entity must recognize a refund liability if the entity receives consideration from a customer and expects to refund
some or all of that consideration to the customer. A refund liability is measured at the amount of consideration
received (or receivable) for which the entity does not expect to be entitled (that is, those amounts are not included in
the transaction price). The refund liability and corresponding change in the transaction price is updated at the end of
each reporting period for changes in circumstances. An entity applies the guidance in Section 4.3.8 to account for a
refund liability relating to a sale with a right of return.
4.3.8 Sale With a Right of Return
FASB REFERENCES
ASC 606-10-55-22 through 55-29
An entity may transfer control of a product to a customer and also grant the customer the right to return the product
for various reasons (such as dissatisfaction with the product) and receive a full or partial refund of any consideration
paid, another product in exchange, or a credit that can be applied against amounts owed, or that will be owed, to
the entity.
An entity’s promise to stand ready to accept a returned product during the return period is not accounted for as a
performance obligation in Step 2. Rather, a sale with a right of return creates variability in the transaction price,
and an entity must apply the guidance on estimating variable consideration (including the guidance on constraining
estimates of variable consideration) to determine the amount of consideration to which the entity expects to be
entitled (that is, excluding the products expected to be returned).
Exchanges by customers of one product for another of the same type, quality, condition and price (for example, one
color or size for another) are not considered returns for the purposes of applying the guidance on sales with a right
of return.
Additionally, contracts in which a customer may return a defective product in exchange for a functioning product are
evaluated in accordance with the guidance on warranties. See Section 3.5 for discussion on accounting for
warranties.
For any amounts received (or receivable) for which an entity does not expect to be entitled, the entity does not
recognize revenue when it transfers products to customers but rather recognizes those amounts received (or
receivable) as a refund liability. Recognition of revenue is limited to the amount of consideration to which the entity
expects to be entitled and therefore, amounts received for products expected to be returned are not recognized in
revenue. The entity also recognizes an asset (and corresponding adjustment to cost of sales) for its right to recover
products from customers on settling the refund liability.
Subsequently, at the end of each reporting period, the entity must update its assessment of amounts for which it
expects to be entitled in exchange for the transferred products and make a corresponding change to the transaction
price and, therefore, of revenue recognized. In addition, an entity must also update the asset and adjustment to
cost of sales representing its right to recover products upon settling the refund liability.
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EXAMPLE 4-7 (ADAPTED FROM ASC 606-10-55-202 THROUGH 55-207): RIGHT OF RETURN
An entity enters 100 contracts with customers. Each contract includes the sale of one product for $10 for a total
consideration of $1,000 (100 total products × $10). Customers pay cash when control of a product transfers to the
customer. The entity’s customary business practice is to allow customers to return any unused product within 30
days for a full refund. The entity’s cost of each product is $6.
The entity applies the portfolio approach to the 100 contracts because it reasonably expects that the effects on the
financial statements from applying a portfolio approach would not differ materially from applying the guidance to
the individual contracts within the portfolio.
The entity determines that the consideration received from the customer is variable because the contract allows a
customer to return the products.
The entity decides to use the expected value method to estimate the variable consideration, which is the method
that it expects to better predict the amount of consideration to which it will be entitled because there is a range of
possible outcomes for how the variability will be resolved. Using the expected value method, the entity estimates
that 3 products will be returned, and 97 products will not be returned.
The entity also applies the guidance on constraining variable consideration to determine whether the estimated
amount of variable consideration of $970 ($10 × 97 products) can be included in the transaction price. The entity
determines that:
Although the returns are outside the entity’s influence, it has significant experience in estimating returns for this
product and customer class.
The uncertainty will be resolved within a short time frame because the return period is 30-days.
Therefore, the entity concludes that it is probable that a significant reversal in the cumulative amount of revenue
recognized (that is, $970) will not occur as the uncertainty is subsequently resolved over the return period.
The entity estimates the costs of recovering the products to be immaterial and expects that the returned products
can be resold at a profit.
Upon transfer of control of the 100 products, the entity recognizes revenue of $970 and does not recognize revenue
for 3 products that it expects to be returned (see Chapter 6 for discussion on recognizing revenue). The entity
records the following journal entries:
Debit Cash $ 1,000 $10 x 100 products transferred to customers
Credit Revenue $ 970 $10 x 97 products not expected to be returned
Credit Refund Liability 30 $10 x 3 products expected to be returned
(Recognition of revenue and a refund liability for the payment received.)
Debit Cost of Sales $ 582 $6 x 97 products not expected to be returned
Credit Asset 18 $6 x 3 products for which it has the right to
recover products upon settling refund liability
Credit Inventory $ 600 $6 x 100 products transferred to customers
(Recognition of cost of sales for products not expected to be returned and an asset for the products expected to be
returned.)
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4.4 SIGNIFICANT FINANCING COMPONENT
FASB REFERENCES
ASC 606-10-32-15 and 32-16
Some contracts with customers include a financing component, which may either be explicitly identified in the
contract or implied by the contractual payment terms of the contract. A contract that has a financing component
conceptually includes two transactions: one for the sale of goods or services, and one for the financing. For example, a
construction entity may require a customer to pay in advance for a long-term construction contract because the
construction entity requires funds to obtain materials to carry out the contract. In the absence of the advance payment
from the customer, the construction entity would typically need to borrow the funds from another party (for example,
banks). The construction entity would need to pay finance charges on those borrowings and would therefore be likely
to recoup those borrowing costs from the customer through a higher transaction price. However, the fair value of the
goods and services transferred to the customer would be the same, the only difference being the party extending the
financing to the construction entity. The amount of the construction entity’s revenue must not vary based on whether
the construction entity receives financing from the customer or from a third party.
Therefore, the transaction price is adjusted for the effects of the time value of money if the timing of payments
provides the customer or the entity with a significant benefit of financing the transfer of goods or services. In those
circumstances, the contract contains a significant financing component, and adjustment to the transaction price is
made to reflect this financing component in the contract.
THE OBJECTIVE OF ADJUSTING THE CONSIDERATION FOR A SIGNIFICANT FINANCING COMPONENT
The objective of adjusting the promised amount of consideration in a contract for a significant financing component
is for an entity to recognize revenue at an amount that reflects the price that a customer would pay for the
promised goods or services if the customer pays cash for those goods or services when (or as) they transfer to the
customer (that is, the cash selling price).
4.4.1 Identifying A Significant Financing Component
FASB REFERENCES
ASC 606-10-32-16 and 32-17
An entity must consider all relevant facts and circumstances in assessing whether a financing component exists in a
contract and whether that financing component is significant to the contract, including:
The difference, if any, between the amount of consideration and the cash selling price of the goods or services
The combined effect of both:
• The expected length of time between when the entity transfers the goods or services to the customer and when
the customer pays for those goods or services
• The prevailing interest rates in the relevant market
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FACTORS TO DETERMINE THAT A SIGNIFICANT FINANCING COMPONENT DOES NOT EXIST
Notwithstanding the above assessment, a contract with a customer does not include a significant financing
component if any of the following factors exist:
The customer has made advance payment for the goods or services and the timing of the transfer of those goods
or services is at the discretion of the customer.
A substantial amount of the consideration promised by the customer is variable, and the amount or timing of
that variable consideration varies based on the occurrence or nonoccurrence of a future event that is not
substantially within the control of either the customer or the entity (for example, if the variable consideration is
a sales-based royalty).
The difference between the promised consideration and the cash selling price of the good or service arises for
reasons other than the provision of finance to either the customer or the entity, and the difference between
those amounts is proportional to the reason for the difference. For example, the payment terms might provide
the entity or the customer with protection from the other party failing to adequately perform under the
contract.
4.4.1.1 Practical Expedient
FASB REFERENCES
ASC 606-10-32-18
An entity may elect a practical expedient to not make adjustments for the effects of a significant financing component
if, at contract inception, the entity expects that the period between when revenue is recognized for the transfer of
the goods or services and the date of payment from the customer will be one year or less.
BDO INSIGHTS — SIGNIFICANT FINANCING COMPONENT — PRACTICAL EXPEDIENT
In some cases, an entity may be eligible to elect the practical expedient even if providing financing to its customers
is a significant component of its revenue transactions. For example, consider a scenario in which an entity resells
consumer products to low-credit quality customers at a high interest rate using extended payment terms that do not
exceed one year. Even if the customer must make all payments within one year from the date revenue is recognized
and the entity is thus eligible to elect the practical expedient, we believe the entity must consider whether the
resulting financial reporting would provide the most relevant and useful information to users of its financial
statements before electing the practical expedient. Entities must also consider the disclosure objective in ASC 606-
10-50-1 and provide sufficient footnote disclosures about such arrangements — see Chapter 8 for discussion on
disclosure requirements.
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EXAMPLE 4-8 (ADAPTED FROM ASC 606-10-55-227 THROUGH 55-232): SIGNIFICANT FINANCING COMPONENT AND
RIGHT OF RETURN
An entity sells a product to a customer for $125, payable in 25 months after delivery. The customer obtains control
of the product at contract inception and has the right to return the product within 90 days from delivery.
The cash selling price of the product is $99 and the entity’s cost of the product is $75.
The entity observes the difference between the amount of promised consideration of $125 and the cash selling price
of $99 at the date that the goods are transferred to the customer and thus determines that the contract includes a
significant financing component. This is because the cash selling price differs from the promised consideration and
no other factors indicate that this difference arises for reasons other than financing.
EXAMPLE 4-9 (ADAPTED FROM ASC 606-10-55-233 AND 55-234): WITHHELD PAYMENTS ON A LONG-TERM
CONTRACT
A construction entity enters a contract for the construction of a building. The performance obligation will be
satisfied over time (see Chapter 6 for discussion on satisfaction of performance obligations). The contract includes
the following payment terms:
The entity will receive scheduled milestone payments based on the performance by the entity throughout the
contract term of two years.
The milestone payments are scheduled to coincide with the entity’s expected performance over the two-year
contract term.
A specified percentage of each milestone payment is withheld by the customer throughout the contract term and
paid to the entity only when the building is complete. The withheld amounts are commonly known as retainage.
The construction entity concludes that the contract does not include a significant financing component because:
The milestone payments coincide with the entity’s performance.
The contract requires retainage for reasons other than the provision of finance because the withholding of
retainage is intended to protect the customer from the entity failing to adequately complete its obligations
under the contract.
TRG DISCUSSIONS — ANALYZING FINANCING COMPONENT WHEN THE PROMISED CONSIDERATION IS EQUAL
TO THE CASH SELLING PRICE
In March 2015, the TRG discussed whether the guidance that includes the objective for adjusting the promised
amount of consideration for a significant financing component (ASC 606-10-32-16) implies that there is never a
significant financing component when the amount of promised consideration is equal to the cash selling price. In
certain industries, it may be common for the promised consideration and cash selling price to be equal. The
following examples were considered:
Example 1 — A customer can purchase a piece of equipment for $1,200 and then will be eligible to purchase
service for the equipment for $100 each month under a month-to-month service contract. However, the
customer could choose to pay zero for the equipment on day one and have the option to sign a note to pay
$1,200 over a 24-month period without an additional charge for interest and still pay $100 each month for
service.
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Example 2 — A furniture retailer offers a promotion for a $2,000 dining set. Customers have the option to obtain
0% financing for three years as part of this special promotion or to pay the entire amount at the time of
purchase.
While the list price of the goods is equal to the promised consideration in the contract in these examples, it is
important to note that the list price might not always equal the cash selling price and a contract might have an
implied interest rate that is different from a stated interest rate. For example, if a customer offers to pay cash
upfront when the entity is offering “free” financing, the customer might be able to pay less than the list price. In
other words, the true cash selling price might be less than the list price. This notion is consistent in concept with
the guidance in ASC 606-10-32-32, which states that a contractually stated price or a list price for a good or service
may be but should not be presumed to be the standalone selling price of that good or service.
If the list price, the cash selling price, and the promised consideration are all equal, an entity should not
automatically assume that there is no significant financing component. The difference, if any, between the amount
of promised consideration and the cash selling price is a factor (that is, it is one of two factors in ASC 606-10-32-16,
not the only factor), not a presumption, in determining whether a significant financing component exists. An entity
must consider all relevant facts and circumstances. Therefore, the one fact that the cash selling price is equal to
the selling price in the contract would not be the totality of the assessment.
An entity must carefully evaluate whether the list price, the cash selling price, and the promised consideration are
all, in fact, equal. If the list price, the cash selling price, and the promised consideration are all, in fact, equal,
that might indicate that the contract does not include a significant financing component. However, that does not
imply that a financing component cannot exist if list price, cash selling price, and promised consideration are equal.
Determining a “cash selling price” may require judgment. The fact that an entity provides “zero interest financing”
does not necessarily mean that the cash selling price is the same as the price another customer will pay over time.
An entity must consider the cash selling price as compared to the promised consideration in making the evaluation
based on the overall facts and circumstances of the arrangement.
It is also possible that a financing component exists but is not significant. An entity is required to apply judgment in
determining whether the financing component is significant or not.
TRG DISCUSSIONS — FINANCING COMPONENT — OTHER ISSUES
In January and March 2015, the TRG discussed several questions about whether a contract includes a significant
financing component.
TRG members agreed that there is no presumption in ASC 606 that a significant financing component exists when
there is a difference in timing between when goods and services are transferred and when the promised
consideration is paid. An entity needs to apply judgment to determine whether the payment terms provide
financing or are for another reason. Many TRG members stated that significant judgment will be required in some
circumstances to determine whether a transaction includes a significant financing component.
TRG members agreed that ASC 606 does not preclude accounting for financing components that are not significant
in the context of the contract.
TRG members also stated that it may not always be clear if cash collected relates to a specific performance
obligation. Therefore, judgment is needed to determine if the practical expedient related to significant financing
component can be applied in scenarios in which there is a single payment stream for multiple performance
obligations.
REVENUE RECOGNITION UNDER ASC 606 99
4.4.2 Accounting for a Significant Financing Component
FASB REFERENCES
ASC 606-10-32-19 and 32-20
When the existence of a significant financing component is identified, an entity determines the discount rate. To meet
the objective of adjusting the consideration in a contract for a significant financing component so that an entity
recognizes in revenue the cash selling price of a good or service transferred, an entity uses the discount rate that
would be reflected in a separate financing transaction between the entity and its customer at contract inception. That
rate would reflect the credit characteristics of the party receiving financing in the contract, as well as any collateral or
security provided by the customer or the entity (which may include assets transferred in the contract). That rate may
be determined by identifying the rate that discounts the nominal amount of the promised consideration to the price
that the customer would pay in cash for the goods or services when (or as) they transfer to the customer. As an
example, a lower than market interest rate might be granted as a sales incentive rather than because of the
creditworthiness of the customer.
After contract inception, an entity does not update the discount rate for changes in interest rates or other
circumstances (for example, a change in the assessment of the customer’s credit risk). In BC243 of ASU 2014-09, the
FASB stated that an entity should not update the discount rate for a subsequent change in circumstances because in
the measurement of the transaction price, an entity should reflect only the discount rate that is determined at
contract inception. This approach is consistent with valuing noncash consideration at contract inception (see
Section 4.5).
EXAMPLE 4-10: ACCOUNTING FOR A SIGNIFICANT FINANCING COMPONENT
An entity enters a contract with a customer to build and supply a new machine. Control over the completed
machine will pass to the customer after two years. (That is, the entity’s performance obligation will be satisfied at
a point in time after two years). The contract contains two payment options. Either the customer can pay $5 million
after two years when it obtains control of the machine, or the customer can pay $4 million at contract inception.
The customer pays $4 million at contract inception.
The entity considers the significant period of time between the date of payment by the customer and the transfer
of the machine to the customer and the effect of prevailing market rates of interest. The entity concludes that
there is a financing component, which is significant to the contract.
The interest rate implicit in the transaction is 11.8%. However, because the entity is effectively borrowing from its
customer, the entity is also required to consider its own incremental borrowing rate, which is determined to be 6%.
The journal entries required are as follows:
At contract inception:
Debit Cash $ 4,000,000
Credit Contract Liability $ 4,000,000
(Recognition of a contract liability for the payment in advance.)
Over the two-year construction period:
Debit Interest expense $ 494,000
Credit
Contract Liability
$ 494,000
(Accretion of the contract liability at a rate of 6%.)
REVENUE RECOGNITION UNDER ASC 606 100
At the date of transfer of the machine to the customer:
Debit Contract Liability $ 4,494,000
Credit Revenue $ 4,494,000
(Recognition of revenue upon the transfer of machine to the customer.)
BDO INSIGHTS — SIGNIFICANT FINANCING COMPONENT
To identify whether there is a significant financing component, an entity compares the timing of payment and the
timing of transfer of control of the related goods or services. How and when the activities related to satisfying the
performance obligation(s) are carried out is not relevant.
For example, when activities related to satisfying a performance obligation are performed over a period of time,
but the revenue related to that performance obligation is recognized at a point in time (such as in Example 4-10),
accounting for a significant financing component may be required. In other words, the fact that the activities are
carried out over a period of time is not relevant when comparing the timing of payment to the point in time at
which the good or service is transferred to the customer to determine whether a significant financing component
exists. See Chapter 6 for discussion on whether revenue is recognized at a point in time or over time.
An entity must also consider whether interest expense arising from adjusting the transaction price for the effect of
a significant financing component should be capitalized into the costs of particular assets in accordance with other
U.S. GAAP (such as ASC 330, Inventory).
An entity presents the effects of financing (interest income or interest expense) separately from revenue from
contracts with customers in the income statement. Interest income or interest expense is recognized only to the extent
that a contract asset (or receivable) or a contract liability is recognized in accounting for a contract with a customer —
see Chapter 8 for discussion on presentation of contract assets, receivables, and contract liabilities.
Additionally, in accounting for the effects of the time value of money, an entity must consider the subsequent
measurement guidance in ASC 835-30, Interest ― Imputation of Interest, specifically the guidance in ASC 835-30-45-1A
through 45-3 on presentation of the discount and premium in the financial statements and the guidance in ASC 835-30-
55-2 and 55-3 on the application of the effective interest method.
TRG DISCUSSIONS — FINANCING COMPONENT — CONTRACT INCLUDES MULTIPLE PERFORMANCE
OBLIGATIONS
In March 2015, the TRG acknowledged that calculating the adjustment of revenue in arrangements that contain
significant financing components and determining how to apply the significant financing component guidance when
there are multiple performance obligations may be complex in some scenarios. However, the standard provides a
framework to address those issues. In calculating the impact of a significant financing component, ASC 606 provides
guidance on selecting a discount rate and other U.S. GAAP provide guidance on subsequent accounting.
The TRG also agreed that it may be appropriate in some circumstances to attribute a significant financing
component to one or more, but not all, of the performance obligations in the contract. Practically, this might be in
a manner analogous to the guidance on allocating variable consideration or allocating a discount — see Chapter 5 for
discussion on allocation of consideration.
REVENUE RECOGNITION UNDER ASC 606 101
4.5 NONCASH CONSIDERATION
FASB REFERENCES
ASC 606-10-32-21 through 32-24
In some cases, an entity might enter a contract with a customer where the payment is in a form other than cash. The
noncash consideration could be in the form of goods or services, a financial instrument (such as stock or warrants), or
property, plant, and equipment. For example, an entity might accept shares of the customer’s stock as payment.
An entity must measure noncash consideration at its estimated fair value at contract inception (that is, the date at
which the five contract existence criteria in Step 1 are met) to determine the transaction price for contracts in which a
customer promises noncash consideration. If an entity cannot reasonably estimate the fair value of the noncash
consideration, the noncash consideration is measured indirectly by reference to the standalone selling price of the
goods or services promised to the customer (or class of customer) in exchange for the consideration.
BDO INSIGHTS — ESTIMATING FAIR VALUE OF NONCASH CONSIDERATION
Estimating the fair value of the noncash consideration received in exchange for transferring goods or services could
be challenging in certain circumstances, for example, when an entity receives shares in a private entity that is in a
start-up stage. However, we believe it would be unusual for an entity to assert that it cannot reasonably estimate
the fair value of the noncash consideration, especially if it is in the form of a financial instrument (for example,
shares).
Once recognized, any asset arising from the noncash consideration is measured and accounted for in accordance with
other relevant U.S. GAAP.
The fair value of noncash consideration may vary after contract inception because of the form of the consideration. For
example, the price of a share received by an entity from a customer in exchange for transferring goods or services may
change subsequently. Changes in the fair value of noncash consideration after contract inception that are due to the
form of the consideration are not included in the transaction price. If the fair value of the noncash consideration
promised by a customer changes for reasons other than the form of the consideration (for example, the exercise price
of a share option changes based on the entity's performance), an entity must apply the guidance on estimating and
constraining variable consideration. If the reasons underlying the change in the fair value of noncash consideration
include both the form of the consideration and reasons other than the form of the consideration, then an entity must
apply the guidance on variable consideration only to the variability resulting from reasons other than the form of the
consideration.
A customer might contribute goods or services to an entity (for example, a customer for a construction contract might
supply materials, equipment, or labor, which the entity will use in performing the construction services). In those
circumstances, an entity must assess whether it obtains control of the contributed goods or services. If so, those
contributed goods or services are accounted for as noncash consideration received from the customer, and the
contractual transaction price is increased by the estimated fair value of the noncash consideration. Similarly, the value
of such contributed materials is included in the cost of the good or service, effectively resulting in a gross up of the
income statement. If the entity does not obtain control of the contributed goods or services, then its estimated fair
value is not included in the transaction price.
Entities must also consider whether contracts involving the receipt of noncash consideration represent contracts with
customers and are thus within the scope of ASC 606. For example, ASC 606 does not apply to:
Barter transactions in which two entities exchange nonmonetary items in the same line of business to facilitate sales
to customers (see Chapter 1 for discussion on nonmonetary exchanges)
Transactions in which an entity accepts a noncash item (for example, shares in a customer entity) in settlement of a
debt owed to the entity
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EXAMPLE 4-11 (ADAPTED FROM ASC 606-10-55-248 THROUGH 55-250): ENTITLEMENT TO NONCASH
CONSIDERATION
An entity enters a contract with a customer on January 1, 20X1, to provide a weekly service for one year (that is, 52
weeks). Work begins immediately. The entity concludes that the service is a single performance obligation because
the entity is providing a series of distinct services that are substantially the same and have the same pattern of
transfer (the services transfer to the customer over time and use the same method to measure progress (a time-
based measure of progress)).
The customer promises 200 shares of its common stock for each week of service as the consideration for the
services (that is, 10,400 shares for the contract). The contractual terms require that the shares must be paid upon
the successful completion of each week of service.
To determine the transaction price (and, hence, the amount of revenue to be recognized), the entity measures the
estimated fair value of 10,400 shares at contract inception on January 1, 20X1. The estimated fair value of 10,400
shares is the transaction price for the contract and is recognized in revenue as the services are transferred to the
customer — see Chapter 6 for discussion on revenue recognition when (or as) a performance obligation is satisfied.
Any changes in the fair value of the 10,400 shares after contract inception is not reflected in the transaction price.
Upon receipt of the shares, the entity applies other U.S. GAAP to determine whether and how any changes in fair
value that occur after January 1, 20X1, is recognized.
BDO INSIGHTS — NONCASH CONSIDERATION
Because of the requirement to measure the fair value of noncash consideration at contract inception in determining
the transaction price in Step 3, an entity may recognize a gain or loss in the income statement upon the initial
recognition of the noncash consideration if the noncash consideration is received after contract inception. To
illustrate, assume in Example 4-11 that the fair value of the shares changes after contract inception due to the form
of the consideration. Assuming that the revenue recognition criteria are met when the shares are actually received
(or become receivable) a week after contract inception, the entity will recognize the following at that date:
Revenue measured using the fair value of the shares at contract inception (included in the transaction price)
A financial asset for the shares at its then current fair value under ASC 321
A gain or loss in the income statement for any changes in the fair value of the shares between contract inception
and the date at which they are received (or become receivable)
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4.6 CONSIDERATION PAYABLE TO A CUSTOMER
FASB REFERENCES
ASC 606-10-32-25 through 32-27 and ASC 606-10-55-251 through 55-254
The following diagram gives an overview of an entity’s recognition of consideration payable to a customer:
In some cases, a contract between an entity and a customer may require an entity to pay consideration to its
customers or customer’s customer (for example, an entity may sell a product to a distributor and subsequently issue a
credit to a customer of that distributor). Consideration payable to a customer includes:
Cash amounts that an entity pays, or expects to pay, to the customer (or to other parties that purchase the entity's
goods or services from the customer)
Credit or other items (for example, a coupon or voucher) that can be applied against amounts owed to the entity (or
to other parties that purchase the entity's goods or services from the customer)
Equity instruments (liability or equity classified) granted in conjunction with selling goods or services (for example,
shares, share options, or other equity instruments)
Can the fair value of the distinct good
or service received from the customer
be reasonably estimated?
Yes
Yes
No
Account for the
purchase of the good
or service in the same
way as other purchases
from suppliers (that is,
as a cost in income
statement).
Account for the payment to customer in excess of the fair
value of the good or service as reduction in revenue.
Account for the payment to customer up to the fair value
of the good or service in the same way as other purchases
from suppliers (that is, as a cost in income statement).
Is the payment to customer in
exchange for a distinct good or
service?
Account for the
payment to customer
as reduction of
revenue.
No
Yes
No
Does the payment to customer exceed
the fair value of the good or service
received from the customer?
REVENUE RECOGNITION UNDER ASC 606 104
Consideration payable to a customer might be a payment in exchange for goods or services received from the
customer, or a discount or refund for goods or services transferred to the customer, or a combination of both. The
amount of consideration received from a customer for goods or services, and the amount of consideration paid to that
customer for goods or services, could be linked even if they are separate events. For example, an entity may overpay
for the goods or services it purchases from its customer and the customer may make inflated payments to the entity for
purchasing goods or services from the entity. To depict revenue faithfully in those cases, any amount accounted for as
a payment to the customer for goods or services received is limited to the fair value of those goods or services, with
any amount in excess of the fair value recognized as a reduction of the transaction price (and, therefore, revenue).
CONSIDERATION PAYABLE TO A CUSTOMER MAY BE ACCOUNTED FOR AS A REDUCTION OF REVENUE
Accordingly, an entity must account for consideration payable to a customer as a reduction of the transaction price
(and therefore of revenue) unless the payment to the customer is in exchange for a distinct good or service that the
customer transfers to the entity. See Chapter 3 for discussion on distinct goods or services.
If consideration payable to a customer is in exchange for a distinct good or service from the customer, an entity
accounts for the purchase of the good or service in the same way that it accounts for other purchases from
suppliers. However, if the amount of consideration payable to the customer exceeds the fair value of the distinct
good or service that the entity receives from the customer, then the entity must account for such an excess as a
reduction of the transaction price (and, therefore, revenue). If the entity cannot reasonably estimate the fair value
of the good or service received from the customer, it must account for all of the consideration payable to the
customer as a reduction of the transaction price (and, therefore, revenue).
CONSIDERATION PAYABLE TO A CUSTOMER MAY BE VARIABLE
If the consideration payable to a customer includes a variable amount, an entity must estimate the transaction
price and assess whether the estimate of variable consideration must be constrained. See Section 4.3 for discussion
on estimating and constraining variable consideration.
If consideration payable to a customer is accounted for as a reduction of the transaction price (and, therefore,
revenue), an entity recognizes the reduction of revenue when (or as) the later of either of the following events occurs:
The entity recognizes revenue for the transfer of the related goods or services to the customer — see Chapter 6 for
discussion of when to recognize revenue.
The entity pays or promises to pay (explicitly or implicitly based on entity’s customary business practices) the
consideration even if the payment is conditional on a future event. For example, a promise to pay a customer that
is conditional on the customer making a specified number of purchases would be reflected in the transaction price
when the entity makes the promise; note that this promise represents variable consideration and, therefore, the
guidance on estimating variable consideration and constraining that estimate (that is, the probability of the
customer making the future purchases) must also be considered.
If a payment to a customer is accounted for as a reduction of the transaction price, an entity recognizes less revenue
when (or as) it satisfies the related performance obligation(s). However, in some cases, an entity promises to pay
consideration to a customer only after it has satisfied its performance obligations and therefore after it has recognized
revenue. In that case, a reduction in revenue is recognized immediately.
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BDO INSIGHTS — CONSIDERATION PAYABLE TO A CUSTOMER THAT IS VARIABLE — IMPLIED PRICE CONCESSION —
TIMING OF RECOGNITION
An entity’s past practice of providing discounts or other price concessions may represent an implied consideration
payable to a customer in the form of variable consideration. Variable consideration is generally estimated and
recognized in revenue before the uncertainty underlying the variability is resolved. If the implied payment to
customer is variable, it may be recognized in revenue (as a reduction) before the entity makes the payment or
explicitly promises to make the payment to the customer. See Section 4.3 for discussion on variable consideration.
TRG DISCUSSIONS — INTERACTION OF THE GUIDANCE ON VARIABLE CONSIDERATION AND CONSIDERATION
PAYABLE TO A CUSTOMER
In January 2015 and March 2015, the TRG discussed the appropriate timing for recognizing consideration payable to
a customer that is variable. The TRG stated that the guidance on consideration payable to a customer states that
such amounts are recognized as a reduction of revenue at the “later of” when:
The related revenue is recognized
The entity pays or promises to pay such consideration
Some TRG members highlighted that if an entity intends to provide its customer with a price concession when
entering the contract (regardless of the form of the price concession, for example, cash payment, rebate, account
credit, or coupon), then the contract includes variable consideration, and the entity must consider that price
concession when estimating variable consideration. If the contract includes variable consideration because of an
expected price concession, then the entity would not wait until it has communicated the price concession to the
customer to recognize a reduction in revenue under the “later of” requirement. Instead, it re-estimates the
expected price concession at each reporting date. The TRG considered the following example:
An entity that manufactures consumer goods enters into a contract to sell a new product to a customer (a retail
store chain) on December 15th. Before delivering any of the new products to the retail store chain, the entity’s
marketing department assesses whether the entity should offer $1-off coupons in newspapers to encourage
customers to buy the new product. The entity will reimburse the retail store chain for any coupons that are
redeemed. The entity has not historically entered into similar coupon offerings in the past.
The entity delivers the new consumer goods (1,000 units at $10/unit) to the retail store chain on December 28th.
Assume for this example, that the customer has no right to return the products. On December 31st, the entity
decides to make the coupon offering. On January 2nd, the entity communicates to its customers that it will
reimburse the retail store chain on March 30th for any coupons redeemed by the retail store’s customers. Assume
the entity prepares its financial statements based on a calendar year end.
TRG members generally agreed that the reversal of revenue from consideration payable to a customer must be
made at the earlier of the date that there is a change in the transaction price (see Section 4.8 for discussion on
changes in transaction price) or the date at which the consideration payable to a customer is promised, especially in
circumstances in which the entity has a past practice of granting a discount. This determination requires judgment.
In the example above, at contract inception, the entity must consider its past practice and other factors (for
example, its intent to offer coupons or if the customer has a reasonable expectation that a concession will be
provided in the form of consideration payable to the customer) to determine whether the transaction price is
variable. If so, the coupon offering constitutes variable consideration, which reduces the transaction price. If all
requirements in Step 5 have been met to recognize revenue for the sale of 1,000 units of consumer goods on
December 28, the entity would reduce the revenue recognized on that date to reflect the estimated amount of
coupon offering (consideration payable to customer). That estimate will be reassessed on December 31 (the
REVENUE RECOGNITION UNDER ASC 606 106
reporting date) in accordance with the guidance on variable consideration (see Section 4.3.6 for discussion on
reassessment of variable consideration).
If the coupon offering does not constitute variable consideration, then the guidance on variable consideration is not
applicable and the “later of” requirement on recognizing consideration payable to a customer applies. In that
scenario, the entity would reduce its revenue to recognize the coupon offering on January 2.
TRG DISCUSSIONS — CONSIDERATION PAYABLE TO A CUSTOMER — DISTRIBUTION CHAIN
The guidance on consideration payable to a customer refers to payments made “to other parties that purchase the
entity’s goods or services from the customer.” BC255 of ASU 2014-09 refers to payments an entity makes to “its
customers or to its customer’s customer (for example, an entity may sell a product to a dealer or distributor and
subsequently pay amounts to or provide a cash incentive to a customer of that dealer or distributor).”
In March 2015, the TRG discussed whether the guidance on consideration payable to a customer applies only to
payments to customers in the distribution chain of an entity or whether “customer’s customer” is interpreted more
broadly.
The TRG considered an example in which an entity that is acting as an agent views the principal in the arrangement
as its customer. The agent may make incentive payments to parties that purchase the principal’s good or service. In
many cases, these incentives are not part of the contract with the principal, or a promise made explicitly or
implicitly to the principal. The principal may, however, be aware of the agent’s incentive program. The agent
makes incentive payments to the principal’s customer, such as providing coupons or cash rebates, to increase the
volume of transactions on which it earns its agency fee. However, the principal’s customers are not purchasing the
agent’s goods or services.
Most TRG members supported the view that an entity’s customers include those parties in the distribution chain and
might include a customer’s customer outside the distribution chain. An entity must identify its customer in each
revenue transaction and entities within the distribution chain. In addition, an entity that is acting as an agent (that
is, arranging for another party to provide goods or services), might identify multiple customers depending on the
facts and circumstances of the arrangement. That is, the entity might view both the principal and the end customer
as customers in the arrangement. Regardless of whether an entity concludes that the principal’s end customer is
also a customer of the entity, a payment to a principal’s end customer that is contractually required based on an
agreement between the entity and the principal represents consideration payable to a customer.
BDO INSIGHTS — CONSIDERATION PAYABLE TO A CUSTOMER — DISTRIBUTION CHAIN
An entity may make payments to a third party on behalf of the customer who may be outside the distribution chain
of the customer. Consistent with the TRG discussions on distribution chain, we believe the guidance on
consideration payable to customer is interpreted broadly and may include payments made to a third party on a
customer’s (or customer’s customer’s) behalf. For example, an entity may agree to pay certain transaction costs,
such as broker fees, on behalf of its customer. Because the entity is not the principal in the arrangement with the
broker, but instead is paying the broker at its customer’s direction, the payment would be recognized as a
reduction in revenue.
REVENUE RECOGNITION UNDER ASC 606 107
TRG DISCUSSIONS — SCOPE OF CONSIDERATION PAYABLE TO A CUSTOMER GUIDANCE
In January 2015 and March 2015, the TRG discussed which payments to a customer are within the scope of the
guidance on consideration payable to a customer. The TRG members had differing opinions about which one of the
following two views is correct:
An entity should assess all consideration payable to a customer (View A).
An entity should assess only consideration payable to a customer included in a contract (or combination of
contracts) with the customer (View B).
The FASB staff concluded that View A is the only supportable interpretation because the FASB acknowledged in
BC257 of ASU 2014-09 that the receipt of consideration from a customer and the payment of consideration to a
customer can be linked even if they are separate events. While some TRG members favored View B, all TRG
members generally agreed that an entity must evaluate a payment to a customer (or to a customer’s customer) —
particularly when no goods or services have been transferred — to determine the commercial substance of the
payment and whether the payment is linked to a revenue contract with the customer.
EXAMPLE 4-12: CONSIDERATION PAYABLE TO CUSTOMER
An entity sells a product to its customer for $100. The contract requires the entity to pay the customer $25.
Scenario A
The customer is not providing any distinct goods and services to the entity. Therefore, the transaction price (and,
hence, revenue) recognized by the entity for the sale of the product is reduced to $75 (that is, $100 - $25).
Scenario B
The contract requires the customer to provide a service to the entity. That service is considered distinct, and its
estimated fair value is $25. Therefore, the transaction price (and, hence, revenue) recognized by the entity for the
sale of the product is $100. The entity separately recognizes the purchase of services from its customer for $25
under other U.S. GAAP.
Scenario C
Consider the same facts in Scenario B with the exception that the estimated fair value of the distinct service
provided by the customer to the entity is $15. Therefore, the transaction price (and, hence, revenue) recognized by
the entity for the sale of the product is reduced to $90 (that is, $100 - $10). $10 is the excess of the consideration
payable to the customer ($25) over the fair value of the distinct service that the entity receives from the customer
($15). The entity separately recognizes the purchase of services from its customer for $15 under other U.S. GAAP.
4.6.1 Determining Whether a Good or Service Received From a Customer is Distinct
To determine whether a payment to a customer is recognized as a reduction in revenue or as a cost in the income
statement, an entity must determine whether it receives a distinct good or service from the customer. See discussion
in Chapter 3 on determining whether a good or service is distinct.
EXAMPLE 4-13 (ADAPTED FROM ASC 606-10-55-251 THROUGH 55-254): CONSIDERATION PAYABLE TO CUSTOMER
An entity that manufactures consumer products enters a contract to sell goods to a customer (a large supermarket
group) for a period of one year. The customer is contractually required to purchase at least $10 million of goods
during the year.
REVENUE RECOGNITION UNDER ASC 606 108
Additionally, the customer is contractually required to make changes to the shelving at the stores that will sell the
retail goods. To compensate the customer for making those changes to shelving, the entity makes a nonrefundable
payment of $1 million to the customer at contract inception.
The payment by the entity to its customer does not result in the entity obtaining a distinct good or service. This is
because although the customer will use the shelving to sell the retail goods purchased from the entity, the entity
does not obtain control of any rights to those shelves.
Therefore, the entity accounts for the $1 million payment to the customer as a reduction in the transaction price
when the entity recognizes revenue for the transfer of retail goods. The $1 million payment is recorded as an asset
and is amortized as a reduction of revenue as the related sales of retail goods are recognized, resulting in total
revenue recognition of $9 million for the contract.
BDO INSIGHTS — DISTINCT GOOD OR SERVICE — SLOTTING FEES
A manufacturer often pays consideration to a retailer to obtain a prominent positioning for the manufacturer’s
goods in the retailer’s shops. Those payments are sometimes referred to as slotting fees. Whether the retailer
provides a distinct good or service to the manufacturer can depend on the specific facts and circumstances,
specifically, whether the manufacturer obtains control of a good or service provided by the retailer. However, we
believe it would be rare for this type of payment to result in the manufacturer receiving control of a distinct good
or service.
BDO INSIGHTS — GOOD OR SERVICE RECEIVED FROM A CUSTOMER
Accounting for payments to customers is a key aspect of ASC 606, which may have a significant effect on the
financial statements of an entity. ASC 606 focuses on whether a good or service received from a customer is distinct
to determine whether a payment to a customer is accounted for as a reduction in revenue or as a cost in the income
statement. Sometimes, general terms such as marketing fees, advertising fees, transportation fees or warehousing
fees are used to describe payments to customers. While those types of fees may be commonly presented as selling
expenses or cost of sales in practice, entities must not assume that is the appropriate presentation when they are
included in a contract with a customer. Rather, entities must carefully evaluate whether the payments to customers
are made in exchange for distinct goods or services. If the good or service received from the customer is not
distinct, the payment to the customer is presented as a reduction of revenue, rather than as a cost of sales or
selling expense.
Determining whether a good or service is distinct requires the application of professional judgment, based on the
facts and circumstances.
BDO INSIGHTS — DISTINCT GOOD OR SERVICE — MARKETING ACTIVITIES
Sometimes it is challenging to determine whether a payment to a customer is in exchange for a distinct good or
service when an entity compensates its customer for the costs of marketing the entity’s products. We believe the
following indicators may be relevant when determining whether the marketing activities provide a service that is
distinct from the sales of the entity’s products to that customer:
Does the marketing activity reach end consumers beyond customers of the entity’s customers?
Could the specific marketing activities be obtained from an unrelated third party also?
REVENUE RECOGNITION UNDER ASC 606 109
Are the marketing activities expected to result in an increase in sales to parties other than the customer
providing the marketing services?
Which entity controls the marketing activities, including making decisions about the content of the marketing
materials?
An entity may sell goods or services to a customer, for example, a retailer, for further resale and the entity may
receive in-store marketing services from the retailer (or digital advertising services on the retailer’s website) to
promote the resale of those goods or services to end customers. In that scenario, we believe it would be unusual to
conclude that the marketing service is distinct from the revenue transaction because the retailer would not provide
the marketing services if it were not also purchasing the goods or services from the entity.
TRG DISCUSSIONS — UPFRONT PAYMENT TO A CUSTOMER OR POTENTIAL CUSTOMER
In November 2016, the TRG discussed the accounting for upfront payments to customers. An entity may make an
upfront payment to a customer, for example, to:
Reimburse the customer for costs associated with entering a contract (such as costs for setting up a new vendor
or costs to shut down operations that will be outsourced to the vendor).
Obtain a contract with a customer in a competitive environment (pay-to-play or exclusivity).
Provide additional incentives or discounts to customers.
Upfront payments to customers that are not in exchange for a distinct good or service are accounted for as a
reduction of the transaction price. However, recognizing a payment to a customer as a reduction in revenue may
result in a loss recognition in certain scenarios. For example:
An entity may make an upfront payment to a potential customer in anticipation of future purchases from the
customer before obtaining a contract with the customer.
An entity may make an upfront payment to a customer with whom the entity has a contract. However, the
upfront payment may relate to the current contract as well as an anticipated future contracts.
The TRG discussed the following two views about the timing of when the reduction in revenue for an upfront
payment should be recorded:
View A — Payments to customers are capitalized and amortized as a reduction of revenue as the related goods or
services that are expected to be purchased by the customer are transferred to the customer. The asset is
assessed for impairment in subsequent reporting periods. Under this view, the payment to a customer might be
recognized in profit or loss over a period that is longer than the current legally enforceable contract. This view is
only appropriate if the payment meets the definition of an asset in FASB Concepts Statement No. 6, Elements of
Financial Statements, and future purchases are expected. See Section 7.7 for discussion on accounting for a
contract asset in a contract with a customer.
View B — Payments to customers are recognized as a reduction of revenue from the existing contract. If a
contract with the customer does not exist, then the entire payment is immediately recognized in profit or loss.
The TRG noted that to apply this view, the payment must relate to the existing contract only.
TRG members agreed that applying either view is not a policy election. Rather, an entity must understand the
reasons for the payment, the rights and obligations resulting from the payment (if any), the nature of the
promise(s) in the contract (if any), and other relevant facts and circumstances for each arrangement when
determining the appropriate accounting.
Finally, the TRG stated that the assessment requires significant judgment in some cases and appropriate disclosures
in the financial statements might be important.
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BDO INSIGHTS — AMOUNTS RECEIVED FROM A SUPPLIER
Although ASC 606 addresses an entity’s accounting for consideration payable to a customer, it does not directly
address how an entity accounts for amounts received from a supplier. ASC 705-20, Cost of Sales and Services ―
Accounting for Consideration Received from a Vendor, provides guidance on accounting for consideration received
from a supplier. We believe that in Example 4-13 the supermarket should reflect a reduction in the cost of
inventory purchased (and, hence, ultimately a reduction in cost of sales) rather than revenue or a contribution
offset against the costs of changing the shelving. Specifically, the supermarket should recognize a $1 million
liability for the “slotting fee” it received, which should be an offset against the cost of inventory when the future
purchases occur.
In that example, the manufacturer is not the retailer’s customer; that is, the changes to the shelving are not an
output of the retailer’s ordinary activities and do not represent a good or service that is distinct from its purchases
from the manufacturer. This results in consistency in the accounting between the manufacturer and the retailer
because if the manufacturer is not receiving a distinct good or service for the consideration paid to the retailer,
then the retailer is similarly not providing a distinct good or service to the manufacturer. This treatment is
consistent with the guidance in ASC 705-20.
However, in other circumstances, a retailer can receive consideration from manufacturers that would constitute
revenue for the retailer. This is illustrated by the following three scenarios:
Scenario A — Discount granted based on purchases not related to manufacturers’ products
A manufacturer and a retailer agree on a promotion under which:
The retailer’s customers receive coupons based on their total purchases in the retailer’s store regardless of
whether the purchased products are manufactured by the manufacturer or another party (assume $10 coupon for
each $100 of purchases).
The retailer’s customers use the coupons to acquire the manufacturers’ products at a discounted price in the
retailer’s stores.
The difference between the sales price and the discounted price granted to the customer is borne by the
manufacturer.
The manufacturer’s product has a selling price of $60. An end customer purchases that product from the retailer in
exchange for three coupons with a total value of $30 and cash of $30. The manufacturer reimburses $30 cash to the
retailer, which is the face value of the coupons used by the end customer. The retailer recognizes revenue in
amount of $60, which includes the $30 cash received from the end customer and the $30 cash reimbursement from
the manufacturer for the coupon used by the end customer.
Scenario B — Promotional discount granted to the customer
A manufacturer and a retailer agree on a promotional pricing for a product manufactured by the manufacturer and
sold by the retailer to end customers. The retailer generally purchases the manufacturer’s product for a price of
$85 for sale to end customers at $102. During the promotional period, the retailer sells the product for $97 to its
customers. The incremental discount of $5 compared to the regular retail price of $102 is reimbursed by the
manufacturer.
For each sale of the product, the retailer recognizes revenue in amount of $102, which includes the price paid by its
customer ($97) plus the amount reimbursed by the manufacturer ($5).
Scenario C — Discount granted to the end-customer based on coupons issued by the manufacturer
A manufacturer (not the retailer) initiates a promotional campaign under which end customers receive coupons
issued by the manufacturer when they purchase the manufacturer’s products from a retailer. When customers use
the coupons, the difference between the retail price and the discounted price is borne by the manufacturer.
Assume a customer receives a coupon for $10 off of the purchase of one of the manufacturer’s products.
The manufacturer’s product has a selling price of $60 and an end customer purchases the product in exchange for a
coupon (with a value of $10) and cash of $50. The retailer receives $10 from the manufacturer. The retailer
REVENUE RECOGNITION UNDER ASC 606 111
recognizes revenue in an amount of $60, which includes the $50 cash received from the end customer and the $10
cash reimbursement from the manufacturer for the coupon used by the end customer.
All Scenarios — Payment on behalf of customer
In all three scenarios, although the payments received by the retailer are from the manufacturer (that is, its
supplier), the payments are received on behalf of the retailer’s customer and, hence, the retailer recognizes the
amounts due from the manufacturer as revenue. If the manufacturer reimburses the retailer at an amount that
exactly matches the discount that the end-customer receives, the coupon has in effect been issued by the
manufacturer (not the retailer) to the end customer and, therefore, is recognized as revenue by the retailer. In
those scenarios, there is no payment to a customer from the perspective of the retailer and therefore, there is no
reduction in revenue or a rebate for the cost of inventory sold.
However, from the manufacturer’s perspective, the reimbursement of coupons is a payment to its customer (that is,
the retailer), and, therefore, results in a reduction of revenue recognized by the manufacturer.
4.6.2 Equity Instruments Granted as Consideration Payable to a Customer
FASB REFERENCES
ASC 606-10-32-23, ASC 606-10-32-25A, ASC 606-10-55-88A and 55-88B
Equity instruments granted by an entity in conjunction with selling goods or services are measured and classified under
ASC 718, Compensation ― Stock Compensation. The equity instrument is measured at the grant date in accordance
with ASC 718 (for both equity-classified and liability-classified share-based payment awards). Changes in the
measurement of the equity instrument (through the application of ASC 718) after the grant date that are due to the
form of the consideration are not included in the transaction price. Rather, changes due to the form of the
consideration are reflected elsewhere in the grantor's income statement.
Changes in the grant-date fair value of an award due to revisions in the expected outcome of a service condition or a
performance condition (both those that affect vesting and those that affect factors other than vesting) are not
considered changes due to the form of the consideration and, hence, are reflected in the transaction price (and,
therefore, revenue).
If the number of equity instruments promised in a contract is variable because of a service condition or a performance
condition that affects the vesting of an award, an entity must estimate the number of equity instruments that it will be
obligated to issue to its customer and update that estimate of the number of equity instruments until the award
ultimately vests in accordance with ASC 718. Additionally, in accordance with ASC 718, the entity must include the
effect of any market conditions and service or performance conditions that affect factors other than vesting when
measuring each instrument. Examples of factors other than vesting are included in ASC 718-10-30-15.
Additionally, when an estimate of the fair value of an equity instrument is required before the grant date in
accordance with the guidance on variable consideration, the estimate is based on the fair value of the award at the
reporting dates that occur before the grant date. An entity must change the transaction price for the cumulative effect
of measuring the fair value at each reporting period after the initial estimate until the grant date occurs. In the period
in which the grant date occurs, the entity must change the transaction price for the cumulative effect of measuring
the fair value at the grant date rather than the fair value previously used at any prior reporting date.
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4.7 NONREFUNDABLE UPFRONT FEES
FASB REFERENCES
ASC 606-10-55-50 through 55-53
An entity may charge a customer a nonrefundable upfront fee at or near contract inception. Examples include:
Joining fees for health club membership contracts
Activation fees for telecommunication contracts
Setup fees in some services contracts (for example, SaaS contracts)
Initial fees in some supply contracts
The following diagram illustrates the key accounting considerations for nonrefundable upfront fees:
When a contract includes a nonrefundable upfront fee, an entity assesses whether that fee relates to the transfer of a
promised good or service in Step 2 and accounts for the fee as follows:
If the nonrefundable upfront fee relates to a good or service, the entity evaluates whether to account for the good
or service as a separate performance obligation.
If the nonrefundable upfront fee does not result in the transfer of a promised good or service to the customer but
rather relates to fulfillment activities, the fee is an advance payment for future goods or services and, therefore, is
recognized as revenue when those future goods or services are provided.
• The revenue recognition period generally extends beyond the initial contract term if the entity grants the
customer renewal options for the contract, which are determined to be material rights — see Section 7.4 for
related discussion.
Does the nonrefundable upfront
fee relate to a good or service?
The entity evaluates whether to
account for the good or service
as a separate performance
obligation.
Recognized as revenue when (or
as) the performance obligation is
satisfied in accordance with the
five-step revenue recognition
model.
The nonrefundable upfront fee
relates to fulfillment activities
and is an advance payment for
future goods or services.
Recognized as revenue when (or
as) the future goods or services
are provided.*
*Revenue recognition period generally extends beyond the initial contract term if the
entity grants the customer a renewal option that is determined to be a material right.
No
Yes
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In many cases, even though a nonrefundable upfront fee may relate to an activity that the entity must undertake at or
near contract inception to fulfill the contract, that activity may not result in the transfer of a promised good or service
to the customer but rather may be a fulfillment activity.
See Chapters 3 and 6 for discussion on identifying fulfillment activities and performance obligations in a contract and
recognizing revenue when or as the performance obligations are satisfied.
EXAMPLE 4-14 (ADAPTED FROM 606-10-55-358 THROUGH 55-360): NONREFUNDABLE UPFRONT FEE — MATERIAL
RIGHT VERSUS ADVANCE PAYMENT FOR SERVICES TO BE PROVIDED IN FUTURE
A technology entity enters a contract with a customer to provide SaaS for one year. The contract includes standard
terms and conditions that are the same for all customers. The customer is contractually required to pay a nominal
nonrefundable upfront fee in return for the entity setting up the customer in the entity's systems and processes.
The customer can renew the contract each year at the standalone selling price of the services and is not required to
pay any additional fee after the initial set up.
The entity observes that:
Its initial setup activities do not transfer a good or service to the customer and, therefore, do not give rise to a
performance obligation.
Although the contract can be renewed without paying another upfront fee, the amount of the fee is not
significant to the price of the services during the renewal period.
Therefore, the entity concludes that the renewal option is priced at the standalone selling price of the services and,
thus, does not provide a material right to the customer — see Section 7.4 for discussion on material rights.
The entity determines that the upfront fee is, in effect, an advance payment for the services to be provided in
future. Therefore, it includes the nonrefundable upfront fee in the transaction price in Step 3 and recognizes it as
revenue for SaaS as SaaS is provided. See Chapter 6 for discussion on recognizing revenue when or as a performance
obligation is satisfied.
4.7.1 Costs Related to Nonrefundable Upfront Fees
An entity may charge a nonrefundable upfront fee in part as compensation for costs incurred in setting up a contract or
other administrative tasks. If those setup activities do not satisfy a performance obligation, but are rather fulfillment
activities (see Section 3.2 for discussion on fulfillment activities), the entity must:
Disregard those setup activities and the related costs when measuring progress to recognize revenue because the
costs of setup activities do not depict the transfer of services to the customer.
Assess whether the costs incurred in setting up a contract result in an asset that is recognized in accordance with
ASC 340-40-25-5 — see Section 7.7 for discussion on contract costs.
4.8 CHANGES IN THE TRANSACTION PRICE
FASB REFERENCES
ASC 606-10-32-42 through 32-45
The transaction price for a contract can change after contract inception for various reasons, including the resolution of
uncertain events or other changes in circumstances that change the amount of consideration to which an entity
expects to be entitled in exchange for the promised goods or services.
An entity must allocate any subsequent changes in the transaction price to the performance obligations in the contract
on the same basis as at contract inception. That is, an entity does not reallocate the transaction price to reflect any
changes in standalone selling prices after contract inception.
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Additionally, an entity allocates a change in the transaction price entirely to one or more, but not all, performance
obligations or distinct goods or services promised in a series that form part of a single performance obligation if the
criteria for the variable consideration allocation exception are met (see Section 5.5 for discussion on the variable
consideration allocation exception).
An amount allocated to a satisfied performance obligation, if any, is recognized as revenue or as a reduction of
revenue in the period in which the transaction price changes. See Example 4-5 in this chapter for an illustration of this
concept.
A change in the transaction price that arises due to a contract modification is accounted for in accordance with the
guidance on contract modifications (see Section 7.3 for related discussion). However, for a change in the transaction
price that occurs after a contract modification, an entity must allocate the change in the transaction price in one of
the following ways, as applicable:
If the modification is accounted for as a termination of the existing contract and the creation of a new contract
(in accordance with ASC 606-10-25-13(a)) — An entity must allocate the change in the transaction price to the
performance obligations identified in the contract before the modification if, and to the extent that, the change in
the transaction price is attributable to an amount of variable consideration promised before the modification.
In all other cases in which the modification is not accounted for as a separate contract (in accordance with
ASC 606-10-25-12) — An entity must allocate the change in the transaction price to the remaining performance
obligations in the modified contract, that is, the performance obligations that were unsatisfied or partially
unsatisfied immediately after the modification.
See Examples 7-9 and 7-11 in Chapter 7 for illustrations of accounting for changes in the transaction price that arise
due to contract modifications.
The standard requires an entity to update its estimate of the transaction price throughout the contract to depict
conditions that exist at the end of each reporting period (and changes in conditions during the reporting period)
because an entity may revise its expectations about the amount of consideration to which it expects to be entitled
after contract inception as uncertainties are resolved or as new information becomes available about remaining
uncertainties. BC224 of ASU 2014-09 states that reflecting current assessments of the amount of consideration to which
the entity expects to be entitled provides more useful information to users of financial statements than retaining the
initial estimates, especially for long-term contracts that are subject to significant changes in conditions during the
lives of the contracts.
In addition, BC227 and BC228 of ASU 2014-09 state that an entity is required to allocate a change in the transaction
price to all the performance obligations in the contract because the resulting cumulative revenue recognized depicts
the revenue that the entity would have recognized at the end of the subsequent reporting period if the entity had the
information at contract inception. Therefore, the transaction price that is allocated to performance obligations that
have already been satisfied is immediately recognized as revenue or as a reduction of revenue.
In some cases, while an entity might make an estimate of the amount of variable consideration to include in the
transaction price at the end of a reporting period, information relating to the variable consideration might arise
between the end of the reporting period and the date when the financial statements are issued or available to be
issued. The FASB decided not to provide guidance on the accounting in these situations because the accounting for
subsequent events is addressed in ASC 855, Subsequent Events.
BDO INSIGHTS — EFFECT OF RECOGNIZED AND NONRECOGNIZED SUBSEQUENT EVENTS ON TRANSACTION PRICE
ASC 855 requires an entity to distinguish between recognized and nonrecognized subsequent events. A recognized
subsequent event provides additional evidence about conditions that existed as of the date of the balance sheet
while nonrecognized subsequent events provide information about conditions that arose after the balance sheet
date. We believe most information related to an entity’s estimate of variable consideration provide better evidence
of the conditions that existed at the balance sheet date and thus is generally considered a recognized subsequent
event that must be reflected in an entity’s estimate of variable consideration.
For example, in the healthcare industry, payments for services are often received from governmental agencies,
such as Medicare or Medicaid. Those payments are subject to regulatory review and audit. If a healthcare entity
receives information from a government payor indicating that reimbursement rates will be higher or lower than
REVENUE RECOGNITION UNDER ASC 606 115
expected before the financial statements are issued or available to be issued, the healthcare entity must consider
that new information when assessing its estimates of variable consideration.
However, events that arise after the balance sheet date are sometimes considered nonrecognized subsequent
events. For example, receipt of FDA approval after the balance sheet date is generally considered a nonrecognized
subsequent event that does not result in recognition of a milestone payment based on FDA approval as of the
balance sheet date.
In some cases, determining whether information obtained after the end of a reporting period provides additional
information about the amount of revenue to which an entity is entitled may require the application of professional
judgment, based on the facts and circumstances.
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CHAPTER 5 — STEP 4: ALLOCATE
THE TRANSACTION PRICE TO THE
PERFORMANCE OBLIGATIONS
5.1 OVERVIEW
After determining the transaction price for the contract in Step 3, at contract inception, an entity must allocate the
transaction price to the performance obligations identified in the contract in Step 2. ASC 606 includes an allocation
objective and generally requires the allocation of transaction price to each performance obligation based on the
relative standalone selling price of the goods or services underlying each performance obligation. Exceptions to the
general allocation based on relative standalone selling prices exist for certain discounts and variable consideration.
In Step 4, determining the appropriate standalone selling price for each performance obligation is the key first step to
appropriately determining the amount to allocate to each performance obligation in a contract. The amount allocated
to each performance obligation is ultimately recognized in revenue when (or as) that performance obligation is
satisfied.
The following diagram summarizes the key concepts in Step 4:
Presentation
and
Disclosures
Scope
Step 1:
Identify the
contract
with a
customer
Step 2:
Identify the
performance
obligations in
the contract
Step 3:
Determine
the
transaction
price
Step 4:
Allocate the
transaction price to
the performance
obligations
Step 5:
Recognize revenue
when or as the
performance
obligation is
satisfied
Other
Topics
REVENUE RECOGNITION UNDER ASC 606 117
Estimate the SSP
Determining the SSP
of a Performance
Obligation
Is an Observable Price Available?
*If the performance obligation is a series of distinct goods or services, allocate the transaction price to each
distinct good or service in an amount that depicts the amount to which the entity expects to be entitled in
exchange for transferring that distinct good or service to the customer. See Section 3.4 for discussion on the
series guidance.
**Use of residual approach has certain restrictions — see Section 5.3 for related discussion
Adjusted market
assessment
approach
Cost plus a margin
approach
Residual approach**
Use the Observable
Price as the SSP
Exception for
Allocation of Discount
Yes
No
Consider Interaction
with the Series
Guidance
(See Section 3.4)
Exception for
Allocation of Variable
Consideration
General Allocation Model
Allocate the transaction price to all
performance obligations based on relative SSPs.
Allocate the transaction price to each performance obligation in an amount that depicts the amount the entity
expects to be entitled in exchange for transferring that performance obligation to the customer.*
Allocation Objective
REVENUE RECOGNITION UNDER ASC 606 118
5.2 ALLOCATION OBJECTIVE
FASB REFERENCES
ASC 606-10-32-28 through 32-29
The objective in Step 4 is to allocate an amount of transaction price to each performance obligation (or distinct good
or service) that reflects the consideration to which an entity expects to be entitled in exchange for transferring the
distinct goods or services (comprising each identified performance obligation) to the customer. This concept is
generally referred to as the “allocation objective.”
5.2.1 General Allocation Model
FASB REFERENCES
ASC 606-20
Standalone selling price is defined as “the price at which an entity would sell a promised good or service separately
to a customer.”
To meet the allocation objective, an entity generally allocates the transaction price to all performance obligations
identified in the contract in proportion to the standalone selling prices of those performance obligations at contract
inception (that is, on a relative standalone selling price basis). This allocation approach is sometimes referred to as the
general allocation model. BC266 of ASU 2014-09 states that in most cases an allocation based on standalone selling
prices faithfully depicts the different margins applicable to multiple promised goods or services sold together in a
contract.
There are certain exceptions to the general allocation model for discounts and variable considerations — see
Sections 5.4 and 5.5 for related discussion.
BDO INSIGHTS — APPROPRIATE LEVEL FOR DETERMINING STANDALONE SELLING PRICE
The standalone selling price is determined at the performance obligation level. When a single performance
obligation is comprised of multiple goods or services, the standalone selling price of that performance obligation is
determined by considering the price at which an entity would sell the bundle separately to a customer, which could
be different than the sum of the prices at which an entity would separately sell the individual goods or services
comprising the bundle.
For example, consider an entity that sells solar panels and related design and installation services as a bundle which
constitutes a single performance obligation. The entity enters a contract to sell that bundle, along with a distinct
service (post-installation maintenance service), to a customer. To allocate the transaction price to the two
performance obligations, that is, the bundle and the maintenance service, the entity must assess the standalone
selling price of the bundle and maintenance service. In determining the standalone selling price of the bundle, the
entity must consider the price at which it would sell the bundle separately to a customer, rather than the price at
which it would separately sell the promised goods or services underlying the bundle (solar panels and design and
installation services) to a customer.
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5.2.2 Allocation if the Contract Includes One Performance Obligation
An entity does not allocate the transaction price if a contract has only one performance obligation (that is, Step 4 is
not applicable). However, if a contract includes a series of distinct goods or services identified as a single performance
obligation (see Section 3.4), then the guidance on allocation of variable consideration may be applicable — see
Section 5.5 for related discussion.
5.3 ALLOCATION BASED ON STANDALONE SELLING PRICE
FASB REFERENCES
ASC 606-10-32-31 through 32-35
At contract inception, an entity must determine the standalone selling price of each performance obligation in the
contract and allocate the transaction price to each performance obligation on a relative standalone selling price basis.
5.3.1 Directly Observable Standalone Selling Price
The best evidence of a standalone selling price is the observable price of a good or service when the entity sells that
good or service separately in similar circumstances and to similar customers.
CONTRACTUALLY STATED PRICE IS NOT PRESUMED TO BE THE STANDALONE SELLING PRICE
While a contractually stated price or a list price for a good or service may be the standalone selling price of that
good or service, it must not be presumed to be the standalone selling price. For example, an entity might typically
grant discounts from its list prices, or it might not sell the distinct good or service separately from other goods or
services. In those scenarios, the list price of a distinct good or service does not provide a directly observable price
of that good or service.
BDO INSIGHTS — DIRECTLY OBSERVABLE STANDALONE SELLING PRICE
Sometimes an entity always sells certain goods or services that are each distinct together at a bundled price. In
determining the standalone selling price of each good and service in the bundle, the entity cannot use the bundled
price as the directly observable standalone selling price of each good and service.
For example, consider an entity that always sells certain electronic equipment and a related service together. The
entity also sells other goods and services, for example, electrical services and home improvement services. Assume
each good and service is a separate performance obligation. The entity enters a contract with a customer to sell an
electronic equipment and the related service, which comprises an entertainment system and a related installation
service. To allocate the consideration in the contract to each performance obligation on a relative standalone
selling price, the entity evaluates whether the standalone selling price of each performance obligation is directly
observable. The entity determines that:
The standalone selling price of the entertainment system and installation service is directly observable because
the entity often sells each separately to customers at its list price.
The standalone selling prices of the electronic equipment and related service (each a separate performance
obligation comprising the entertainment system) are not directly observable because the equipment and related
service are always sold together, and the list price reflects the price for the bundle.
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The standalone selling prices of the electronic equipment and related service comprising the entertainment system
are not directly observable even if the equipment and related service are priced separately in the contract.
Because they are never sold on a standalone basis, the entity cannot assume that the contract price is the
standalone selling price.
Therefore, the entity must estimate the standalone selling price of the electronic equipment and related service —
see Section 5.3.2 for related discussion.
5.3.2 Estimating Standalone Selling Price
If a standalone selling price is not directly observable, an entity estimates the standalone selling price at an amount
that would result in the allocation of transaction price meeting the allocation objective.
INFORMATION CONSIDERED IN ESTIMATING STANDALONE SELLING PRICE
In estimating a standalone selling price, an entity must consider all information that is reasonably available to the
entity, including:
Market conditions
Entity-specific factors
Information about the customer or class of customer
In considering the information available to estimate a standalone selling price, an entity must:
Maximize the use of observable inputs
Apply estimation methods consistently in similar circumstances
BDO INSIGHTS — ESTIMATING STANDALONE SELLING PRICE — RANGE
A question comes up in practice as to whether the standalone selling price must be estimated as a precise amount
or whether it could be estimated as a range. While ASC 606 is silent on this question, we believe the standalone
selling price of a performance obligation can be derived from a range of amounts if all of the below conditions are
met:
The range is sufficiently narrow
The entity would sell the performance obligation separately to a customer at any point within the range
The resulting allocation outcome is consistent with the allocation objective
Determining an appropriate range of standalone selling prices requires the application of professional judgment,
based on the facts and circumstances. An entity must maximize the use of observable inputs and consider the
circumstances of the contract (for example, class of customer) in determining the range.
The use of a range is not appropriate when the standalone selling prices are so widely dispersed that an appropriate
standalone selling price for a performance obligation in a transaction is not determinable.
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BDO INSIGHTS — SIGNIFICANCE OF STANDALONE SELLING PRICE IN DISAGGREGATED REVENUE DISCLOSURES
A contract with a customer may include multiple performance obligations that have the same pattern and timing for
revenue recognition. This would happen when:
Multiple performance obligations are satisfied at the same point in time. For example, this would happen in a
contract to deliver 10 products (each a separate performance obligation satisfied at a point time) that are all
delivered at the same point in time rather than at different points in time.
Multiple performance obligations are satisfied concurrently over time over the same term and have the same
measure of progress. For example, this would happen in a contract to provide SaaS and customer support that
are coterminous and have a time-based measure of progress.
In each of these situations, because control of the performance obligations is transferred to the customer at the
same time, the allocation of the consideration in the contract to the performance obligations (or distinct services)
may have no practical effect on the amount and timing of revenue recognition. However, if an entity presents the
performance obligations in separate lines in the income statement or if its disaggregated revenue disclosure results
in separate disclosure of the distinct performance obligations, then the entity must determine standalone selling
prices of its performance obligations in accordance with ASC 606. The entity cannot presume the contractually
stated or list price is the standalone selling price of each. In other words, an entity would need to determine
standalone selling prices to comply with the presentation and disclosure requirements even if, as a practical
matter, it does not allocate the transaction price in Step 4 (because all the performance obligations have same
pattern and timing for revenue recognition).
See Chapters 6 and 8 for discussion on recognizing revenue and disclosure requirements, respectively.
Suitable methods for estimating the standalone selling price of a good or service include, but are not limited to, the
following three approaches:
Adjusted market assessment approach
Expected cost plus a margin approach
Residual approach
While ASC 606 does not specify a hierarchy of evidence to estimate the standalone selling price of a good or service,
BC274 of ASU 2014-09 states the FASB’s decision to emphasize that an entity must maximize the use of observable
inputs when developing estimates of standalone selling prices. Further, BC268 of ASU 2014-09 states that the
estimation approaches (adjusted market assessment approach, expected cost plus a margin approach and residual
approach) are “examples of suitable estimation methods for estimating the standalone selling price.” It also states that
the FASB decided not to preclude or prescribe any particular method for estimating a standalone selling price so long
as the estimate is a faithful representation of the price at which the entity would sell the distinct good or service if it
were sold separately to the customer. The method used by an entity to estimate a standalone selling price must
maximize the use of observable inputs and must be applied consistently to estimate the standalone selling prices of
other goods or services with similar characteristics.
Additionally, in BC269 of ASU 2014-09, the FASB observed that when developing processes for determining standalone
selling prices, an entity must consider all reasonably available information based on the specific facts and
circumstances, including:
Reasonably available data points, such as a standalone selling price of the good or service, the costs incurred to
manufacture or provide the good or service, related profit margins, published price listings, third-party or industry
pricing, and the pricing of other goods or services in the same contract
Market conditions, including supply and demand for the good or service in the market, competition, restrictions,
and trends
Entity-specific factors, such as business pricing strategy and practices
Information about the customer or class of customer, such as type of customer, geographical region, and
distribution channel
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5.3.2.1 Adjusted Market Assessment Approach
This approach:
Requires an evaluation of the market in which an entity sells goods or services to estimate the price that a customer
in that market would be willing to pay for those goods or services
May include referring to prices from the entity's competitors for similar goods or services and adjusting those prices
as necessary to reflect the entity's costs and margins
5.3.2.2 Expected Cost Plus a Margin Approach
This approach requires an entity to forecast its expected costs of satisfying a performance obligation and then add an
appropriate profit margin.
5.3.2.3 Residual Approach
This approach requires an estimation of standalone selling price by reference to the total transaction price less the
sum of the observable standalone selling prices of other goods or services promised in the contract.
This approach may be used to estimate the standalone selling price of a good or service only if both of the following
conditions are met:
The entity has observable standalone selling prices for one or more other goods or services promised in the contract
One of the following criteria is met:
• The entity sells the same good or service to different customers at or near the same time for a broad range of
amounts. That is, the selling price is highly variable because a representative standalone selling price is not
discernible from past transactions or other observable evidence.
• The entity has not yet established a price for that good or service, and the good or service has not previously
been sold on a standalone basis. That is, the selling price is uncertain.
Furthermore, a combination of methods may be used to estimate the standalone selling prices of the goods or services
in a contract if two or more of those goods or services have highly variable or uncertain standalone selling prices. For
example, a residual approach may be used to estimate the aggregate standalone selling price for multiple promised
goods or services with highly variable or uncertain standalone selling prices and then another method may be used to
estimate the standalone selling prices of the individual goods or services relative to that estimated aggregate
standalone selling price determined by the residual approach. However, to use the residual approach to estimate the
aggregate standalone selling price for multiple promised goods or services, the observable standalone selling prices of
other goods or services promised in the contract must be available.
When an entity uses a combination of methods to estimate the standalone selling price of each promised good or
service in the contract, the entity must evaluate whether allocating the transaction price at those estimated
standalone selling prices would be consistent with both of the following:
The allocation objective.
The requirement in ASC 606-10-32-33 to estimate the standalone selling price at an amount that would result in the
allocation of the transaction price meeting the allocation objective.
Additionally, BC273 of ASU 2014-09 states that when the residual approach is used to determine the standalone selling
price of a distinct good or service, the outcome of this approach cannot realistically result in a standalone selling price
of zero if the good or service is in fact distinct. To be distinct, a good or service must have value on a standalone basis.
Therefore, if the residual approach results in no, or very little, consideration being allocated to a performance
obligation, the entity must consider whether that estimate is appropriate in those circumstances. If not, the entity
must use another method to estimate standalone selling price.
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BDO INSIGHTS — RESIDUAL APPROACH — SOFTWARE LICENSE AND MAINTENANCE SERVICE
In some situations, a distinct good or service is never sold separately by an entity. Instead, it is sold as part of a
bundle, which may be sold for a broad range of amounts. This is common in the software industry where software
licenses are often bundled with maintenance for an initial period. Software maintenance (Post Contract Support
(PCS)) can typically be renewed after the initial period on a standalone basis. However, the license and the PCS
could represent separate performance obligations even though the entity might never sell one without the other
(see Chapter 3 for discussion on identifying separate performance obligations).
In certain circumstances, an entity may have strong pricing policies for PCS by which the entity charges customers a
fixed amount for maintenance renewals, and the price does not vary from customer to customer. This could also be
the case if PCS renewals are stated as a percentage of the list price of a license (that is, the list price before any
customer-specific discounts or adjustments) provided that the list price is not subject to significant regular,
artificial adjustments.
This scenario leads to the question of whether it would be acceptable for an entity to apply the residual approach
to establish the standalone selling price for a license that is never sold separately.
We believe using a residual approach to calculate the standalone selling price of the software license is appropriate
if an entity can identify that the pricing variability that exists in the software license and PCS bundle is attributable
to the software license, and that the standalone selling price of the PCS is not highly variable. Although an entity
may not sell the software license on its own for a broad range of amounts, the entity may sell a bundle that
contains both software and PCS for a broad range of amounts. There may be observable evidence that a PCS
renewal is always sold for either a fixed amount, or a fixed percentage of the list price or of the contractual price
of the software license. In this case, an entity can identify that it is the license component of the bundle that is
sold to different customers for a broad range of amounts, and not the PCS (because there is an observable
standalone selling price for the PCS). If there are no other goods or services in the bundle for which observable
standalone selling price does not exist, then the use of the residual approach may be appropriate to calculate the
standalone selling price of the license.
Determining standalone selling prices of software licenses and PCS requires application of professional judgment,
based on the facts and circumstances.
EXAMPLE 5-1 (ADAPTED FROM ASC 606-10-55-256 THROUGH 55-258): ALLOCATION METHODOLOGY
An entity sells three products (A, B, and C) to a customer for $200. Each product will be transferred to the customer
at a different point in time. Assume each product represents a separate performance obligation, which is satisfied
at a point in time.
Product A is regularly sold separately for $100 and, therefore, the standalone selling price of product A is directly
observable. Products B and C are not sold separately and, therefore, the standalone selling price of products B
and C are not directly observable. The entity estimates the standalone selling prices of products B and C as $50 and
$150, respectively.
Product SSP
A $ 100
B 50
C 150
Total $ 300
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There is no evidence that suggests the discount of $100 (sum of the standalone selling prices, $300, less the
transaction price, $200) relates entirely to one, or a group of two, of the products being sold (see Section 5.4 for
discussion on allocation of a discount). Therefore, the discount is allocated proportionately to the three products
and the allocated transaction price is as follows:
Product Allocated Transaction Price
A (200 x (100/300)) = $67
B (200 x (50/300)) = $33
C (200 x (150/300)) = $100
Total $200
5.4 ALLOCATION OF A DISCOUNT
FASB REFERENCES
ASC 606-10-32-36 through 32-38
While the general allocation model based on relative standalone selling prices is the default method for allocating the
transaction price, the allocation of a discount using relative standalone selling prices may not always result in a
faithful depiction of the amount of consideration to which the entity expects to be entitled from the customer. For
example, in a contract that includes both a high-margin and a low-margin item, the allocation of a discount based on
the relative standalone selling prices could result in a loss on one part of the contract although the contract may be
profitable in total. Therefore, the standard includes an exception to the general allocation model for allocation of a
discount (hereinafter, referred to as “discount allocation exception”).
A discount exists if the sum of the standalone selling prices of the goods or services in a contract exceeds the
consideration payable by the customer.
Unless there is observable evidence that an entire discount relates to only one or some (but not all) performance
obligations in a contract, the discount is allocated proportionately to all performance obligations in the contract based
on relative standalone selling prices.
5.4.1 Observable Evidence and Specific Allocation of a Discount
The entire discount is allocated to only one or some (but not all) performance obligations in a contract if all of the
following three criteria are met:
Regular standalone sales — Each distinct good or service (or each bundle of distinct goods or services) in the
contract is sold regularly by the entity on a standalone basis.
Regular standalone sales of a bundle at discount — A bundle (or bundles) of some of those distinct goods or
services are also sold regularly by the entity on a standalone basis at a discount to the sum of the standalone selling
prices of the goods or services in each bundle.
Discount in the contract is substantially the same as the discount in regular standalone sales of a bundle — The
discount attributable to each bundle of goods or services in regular standalone sales of the bundle is substantially
the same as the discount in the contract. Additionally, an analysis of the goods or services in each bundle provides
observable evidence of the performance obligation(s) to which the entire discount in the contract relates.
For example, observable evidence that a discount relates to only some (but not all) performance obligations in a
contract may exist if a contract includes a discount for the sale of three goods but two of those goods are also often
sold together at a discount to the sum of the standalone selling prices of those two goods.
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HIERARCHY IN APPLYING THE DISCOUNT ALLOCATION EXCEPTION AND THE RESIDUAL APPROACH FOR
ESTIMATING STANDALONE SELLING PRICE
If a discount is allocated entirely to one or more performance obligations in the contract, an entity must allocate
the discount before using the residual approach to estimate the standalone selling price of a good or service. See
Examples 5-2, 5-3 and 5-4 in this chapter.
5.4.2 Application of the Discount Allocation Exception
BC283 of ASU 2014-09 states that discount allocation exception would generally apply to contracts in which there are
at least three performance obligations. This is because an entity could show that a discount relates to two or more
performance obligations when it has observable information supporting the standalone selling price of a bundle of
those promised goods or services when they are sold together. While it may be possible for an entity to have sufficient
evidence to allocate a discount to only one performance obligation, the FASB expected that to occur in rare cases only.
In BC282 of ASU 2014-09, the FASB considered whether the discount allocation exception is too restrictive, which might
result in outcomes that are inconsistent with the economics of some transactions. The FASB’s view was that the
discount allocation exception is included to maintain the rigor and discipline of a relative standalone selling price
allocation and therefore it appropriately limits the situations in which a discount would not be allocated pro rata to all
performance obligations in the contract. In other words, limiting the applicability of discount allocation exception was
intentional.
EXAMPLE 5-2 (ADAPTED FROM ASC 606-10-55-259 THROUGH 55-269): ALLOCATING A DISCOUNT AND RESIDUAL
APPROACH
An entity regularly sells three products (A, B, and C) individually and has, therefore, established the following
directly observable standalone selling prices:
Product SSP
A $ 80
B 110
C 90
Total $ 280
Additionally, the entity regularly sells products B and C together for $120. Assume each product represents a
separate performance obligation, which is satisfied at a point in time.
The entity enters a contract to sell three products (A, B, and C) to a customer for $200. Each product will be
transferred to the customer at a different point in time. The contract includes a discount of $80 (sum of the
standalone selling prices, $280, less the transaction price, $200) for the sale of three products together. However,
the entity has evidence that products B and C are regularly sold together at $120 rather than at $200 ($110 + $90,
the sum of their standalone selling prices). That is, a discount of $80 is regularly applied to the sale of products B
and C together. Therefore, the entire discount of $80 in the contract is allocated to products B and C only. The
selling price attributed to products B and C is determined first and a residual amount is attributed to product A.
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The entity allocates $120 of the transaction price (which incorporates the entire discount of $80) to the products B
and C (standalone selling price of $110 and $90 respectively) as follows:
Product Allocated Transaction Price
B ($120 x ($110/$200)) = $66
C ($120 x ($90/$200)) = $54
Total $120
The residual transaction price of $80 ($200 - $120) is allocated to product A.
EXAMPLE 5-3 (ADAPTED FROM ASC 606-10-55-259 THROUGH 55-269): ALLOCATING A DISCOUNT AND RESIDUAL
APPROACH — RESIDUAL APPROACH IS APPROPRIATE
Consider the same facts in Example 5-2 except the contract also includes the sale of an additional product D and
the consideration payable by the customer is $260. Each product will be transferred to the customer at a different
point in time. The standalone selling price of product D is highly variable because it is sold to different customers
for a broad range of amounts ($30 - $90). Therefore, the entity decides to use the residual approach to estimate the
standalone selling price of product D.
Before applying the residual approach to estimate the standalone selling price of product D, the entity considers
whether any discount must be specifically allocated to one or more (but not all) performance obligations in the
contract.
As discussed in Example 5-2, the entity has observable standalone selling prices for standalone sale of product A
($80) and bundled sale of products B and C together ($120). That is, there is observable evidence that $200 of the
transaction price must be allocated to products A, B and C and a $80 discount must be allocated entirely to
products B and C together. The entity determines the estimated standalone selling price of product D $60 under the
residual approach as follows:
Product SSP
A $ 80
B and C 120
D 60
Total $ 260
The entity considers whether the resulting allocation is consistent with the allocation objective and the guidance on
estimating the standalone selling price. The entity concludes that the resulting allocation is appropriate because
$60 allocated to product D is within the range of its observable selling prices ($30 - $90).
EXAMPLE 5-4 (ADAPTED FROM ASC 606-10-55-259 THROUGH 55-269): ALLOCATING A DISCOUNT AND RESIDUAL
APPROACH — RESIDUAL APPROACH IS NOT APPROPRIATE
Consider the same facts in Example 5-3 except the consideration payable by the customer is $210. In this case, the
residual approach would result in an estimated standalone selling price of $10 for product D ($210 transaction price
less $200 allocated to products A, B, and C). The entity observes that $10 does not approximate the standalone
selling price of product D, which ranges from $30 - $90. Therefore, the entity concludes that $10 would not
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faithfully depict the amount of consideration to which the entity expects to be entitled in exchange for the sale of
product D.
Therefore, the entity reviews its observable data, including sales and margin reports, to estimate the standalone
selling price of product D using another suitable method. In this case, the entity allocates the transaction price of
$210 to products A, B, C and D on a relative standalone selling price basis.
BDO INSIGHTS — ALLOCATION OF DISCOUNT
It is common for entities in the retail sector to ‘bundle’ several different goods together and sell them at a
discount. Although the approach set out in ASC 606 appears straightforward, determining an appropriate basis to
allocate discounts and evaluating whether the allocation objective is met requires the application of professional
judgment, based on the facts and circumstances. This may be particularly complex if an entity also expects to apply
a residual approach. For example, the entity may have to consider the range of prices at which each good within a
bundle has historically been sold separately to appropriately apply the discount allocation exception and the
residual approach.
5.5 ALLOCATION OF VARIABLE CONSIDERATION
FASB REFERENCES
ASC 606-10-32-39 through 32-41
The application of the general allocation model based on relative standalone selling prices to a contract that includes
multiple performance obligations and variable consideration results in the allocation of variable consideration to all
performance obligations in the contract. However, this may not necessarily result in a faithful depiction of the amount
of consideration to which the entity expects to be entitled from the customer upon satisfying a particular performance
obligation if the variable consideration does not relate to all the performance obligations in the contract. For example,
an entity may contract to sell two products that are delivered at different points in time with a bonus fee payable by
the customer that is contingent on the timely delivery of only the second product. In that example, it might be
inappropriate to allocate the bonus (a variable consideration that is included in the transaction price) to both
products. Therefore, an exception to the general allocation model was provided for allocation of variable consideration
(hereinafter, referred to as the “variable consideration allocation exception”).
Variable consideration in a contract may be attributable to the entire contract or to a specific part of the contract,
such as either of the following:
One or more, but not all, performance obligations in the contract. This would apply if, for example, a bonus is
contingent on an entity transferring a good or service within a specified period of time.
One or more, but not all, distinct goods or services promised in a series of distinct goods or services that forms part
of a single performance obligation (see Section 3.4 for discussion on the series guidance). This would apply if, for
example, the consideration promised for the second year of a two-year cleaning service contract will increase based
on movements in a consumer price index.
The variable consideration allocation exception states that an entity allocates a variable amount of consideration (and
subsequent changes to that amount) entirely to a single performance obligation (or a distinct good or service that
forms part of a single performance obligation that meets the definition of a series) if both of the following criteria are
met:
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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).
When considering all of the performance obligations and payment terms in the contract, the allocation of the
variable amount in its entirety to a performance obligation (or distinct good or service) is consistent with the
allocation objective that the transaction price must be allocated to each performance obligation (or distinct good or
service) to reflect the consideration to which the entity expects to be entitled in exchange for transferring the
promised good or service.
An entity applies the general allocation model (see Section 5.2.1) and the discount allocation exception (see
Section 5.4) to allocate the remaining amount of transaction price that does not meet the criteria for the variable
consideration allocation exception.
TRG DISCUSSIONS — ALLOCATION OF VARIABLE CONSIDERATION TO A DISTINCT GOOD OR SERVICE IN A
SERIES
In July 2015, the TRG discussed whether the allocation of variable consideration to a distinct good or service in a
series is required to be based on standalone selling prices. That could have limited the number of transactions that
qualify for the variable consideration allocation exception because it might imply that each distinct service that is
substantially the same would need to be allocated the same amount (absolute value) of variable consideration.
ASC 606-10-32-29 states that to meet the allocation objective, an entity shall allocate the transaction price to each
performance obligation on a relative standalone selling price basis. However, that paragraph specifically excludes
ASC 606-10-32-39 through 32-41 on allocating variable consideration to a distinct service in a series from this
requirement. Additionally, ASC 606-10-32-30 states that the guidance in ASC 606-10-32-31 through 32-41 on the
relative standalone selling price allocation does not apply to the allocation of variable consideration. BC280 of
ASU 2014-09 describes that while standalone selling price is the default method for determining whether the
allocation objective is met, the FASB decided that other methods could be used in certain instances and, therefore,
included the guidance on allocating variable consideration.
Based on the above considerations, the TRG agreed that an allocation based on relative standalone selling prices is
not required to meet the allocation objective when allocating variable consideration to a distinct good or service in
a series. However, as illustrated in Example 35 in ASC 606 (see adaptations in Examples 5-5 and 5-6 in this chapter)
where variable consideration is allocated to different performance obligations, standalone selling prices in some
cases might be utilized (but are not required to be utilized) to determine the reasonableness of the allocation.
The FASB did not describe other methods that could be used to comply with the allocation objective other than
stating in ASC 606-10-32-40(b) that an entity must consider all the payment terms and performance obligations. For
instance, an entity might consider its effort to fulfill the obligation and whether the variable consideration is
commensurate with the value provided to the customer. As such, an entity must apply reasonable judgment to
determine whether the allocation results in a reasonable outcome.
The following examples were discussed by the TRG. The examples below are not all-inclusive, and there could be
other reasons why a variable fee would or would not meet the allocation objective.
Example A
IT Seller and IT Buyer execute a 10-year IT Outsourcing arrangement in which IT Seller provides continuous delivery
of outsourced activities over the contract term. For example, the IT seller will provide server capacity, manage the
customer’s software portfolio, and run an IT help desk. The total monthly invoice is calculated based on different
units consumed for the respective activities. For example, the billings might be based on millions of instructions per
second of computing power, number of software applications used, or number of employees supported, and the
price per unit differs for each type of activity.
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Before the delivery of the service, IT Seller performs certain initial set-up activities to be able to provide the other
services in the contract. IT Seller charges the IT Buyer a nonrefundable upfront fee related to the transition
activities. IT Seller concludes that the set-up activities do not transfer services to the customer.
The per unit price IT Seller charges declines over the life of the contract. The agreed upon pricing at the onset of
the contract is considered to reflect market pricing. The pricing decreases to reflect the associated costs decreasing
over the term of the contract as the level of effort to complete the tasks decreases. Initially, the tasks are
performed by more expensive personnel for activities that require more effort. Later in the contract, the level of
effort for the activities decreases, and the tasks are performed by less expensive personnel. The contract includes a
price benchmarking clause whereby the IT Buyer engages a third-party benchmarking firm to compare the contract
pricing to current market rates at certain points in the contract term. There is an automatic prospective price
adjustment if the benchmark is significantly below IT Seller’s price.
Assume IT Seller concludes that there is a single performance obligation that is satisfied over time because the
customer simultaneously receives and consumes the benefits provided by its services as it performs.
In this example, the events that trigger the variable consideration are the same throughout the contract, but the
price per unit decreases each year. Even with the declining prices, the allocation objective could be met if the
pricing is based on market terms or the changes in price are substantive and linked to changes in the entity’s cost to
fulfill the obligation or value provided to the customer based on the third-party benchmarking data.
Example B
Transaction Processer (TP) enters a 10-year agreement with a customer. Over the 10-year period, TP will provide
continuous access to its system and process all transactions on behalf of the customer. The customer is obligated to
use TP’s system to process all of its transactions; however, the ultimate quantity of transactions is not known. TP
concludes that the customer simultaneously receives and consumes the benefits as it performs.
TP charges the customer on a per transaction basis. For each transaction, the customer is charged a contractual
rate per transaction and a percentage of the total dollars processed. TP also charges the customer a fixed upfront
fee at the beginning of the contract.
If the nature of the entity’s promise is a single service to process as many transactions as the customer requires, the
fees based on quantity processed and the fees based on a percentage of dollars processed could meet the allocation
objective for each month of service. For example, the allocation objective could be met if the fees are priced
consistently throughout the contract and the rates charged are consistent with the entity’s standard pricing
practices with similar customers.
Example C
Hotel manager (HM) enters a 20-year agreement to manage properties on behalf of the customer. HM receives
monthly consideration based on 1% of monthly rental revenue, reimbursement of labor costs incurred to perform
the service and an annual incentive payment based upon 8% of gross operating profit. HM concludes that the
customer simultaneously receives and consumes the benefits provided by its services as it performs.
In this example, the base monthly fees could meet the allocation objective for each month because there is a
consistent measure throughout the contract period that reflects the value to the customer each month (the % of
monthly sales). Similarly, if the labor cost reimbursements are commensurate with the entity’s efforts to fulfill the
promise each day, then the allocation objective for those variable fees could also be met. Finally, the allocation
objective could also be met for the incentive fee if it reflects the value delivered to the customer for the annual
period (reflected by the profits earned) and is reasonable compared to the incentive fees that could be earned in
other periods.
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EXAMPLE 5-5 (ADAPTED FROM ASC 606-10-55-270 THROUGH 55-279): ALLOCATION OF VARIABLE
CONSIDERATION — ENTIRELY TO ONE PERFORMANCE OBLIGATION
An entity enters a contract with a customer for two licenses of IP (licenses A and B). Assume each license represents
a separate performance obligation, which is satisfied at a point in time when it is transferred to the customer. The
standalone selling prices of licenses A and B are $1,200 and $1,500, respectively.
The consideration payable by the customer is as follows:
License A: a fixed amount of $1,200
License B: a royalty payment of 5% of the selling price of the customer’s future sales of products that use the IP
to which license B relates
The entity estimates that the amount of sales-based royalties that it will be entitled to in respect of license B will
be about $1,500.
The entity then considers the criteria in the variable consideration allocation exception to determine the allocation
of the transaction price to each of the two licenses. The entity determines that:
The variable consideration (sales-based royalty) relates specifically to an outcome from the entity’s performance
obligation to transfer license B (that is, the customer's subsequent sales of products that use that license).
Allocating the expected sales-based royalty amounts of $1,500 entirely to license B is consistent with the
allocation objective, because the estimated amount of royalties approximates the standalone selling price of
license B ($1,500) and the fixed amount of $1,200 approximates the standalone selling price of license A. Based
on an assessment of the facts and circumstances relating to both licenses, the entity determines that allocating
some of the fixed consideration ($1,200) to license B in addition to all of the variable consideration would not
meet the allocation objective.
Therefore, the entity allocates the transaction price as follows in accordance with the variable consideration
allocation exception:
License A: $1,200
License B: the variable royalty payment
Although revenue of $1,200 will be recognized for license A when it is transferred to the customer, no revenue will
be recognized when license B is transferred to the customer. Sales-based royalties allocated to license B are not
recognized before the subsequent sales of the customer’s products that use license B take place because of the
exception in ASC 606-10-55-65 that precludes estimation of sales- or usage-based royalties for licenses of IP (see
Section 7.5 for discussion on licensing).
In contrast to this example, the allocation of variable consideration is different in Example 5-6 below because the
contractual prices do not reflect standalone selling prices of the licenses.
EXAMPLE 5-6 (ADAPTED FROM ASC 606-10-55-270 THROUGH 55-279): ALLOCATION OF VARIABLE
CONSIDERATION — BASED ON STANDALONE SELLING PRICES
Assume the same fact pattern in Example 5-5, except that the prices included in the contract are:
License A: a fixed amount of $450
License B: a royalty payment of 7.5% of the selling price of the customer’s future sales of products that use
license B
The entity estimates that the amount of sales-based royalties that it will be entitled to in respect of license B will
be about $2,250.
The entity then considers the criteria in the variable consideration allocation exception to determine the allocation
of the transaction price to each of the two licenses. The entity determines that in this case, although the variable
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payments (the sales-based royalties) relate solely to the transfer of license B, allocating the variable consideration
only to license B would be inappropriate. This is because allocating $450 to license A and $2,250 to license B would
not reflect a reasonable allocation based on the standalone selling prices of those two licenses. As a result, the
entity must apply the general allocation model based on relative standalone selling prices.
Allocation of the fixed consideration
The entity allocates the fixed amount of $450 to the two licenses based on their standalone selling prices. This
allocation is calculated as:
Product Allocated Transaction Price
License A ($450 x ($1,200/$2,700)) = $200
License B ($450 x ($1,500/$2,700)) = $250
Total $450
Allocation of the variable consideration
As the sales by the customer of products that use license B occur, the sales-based royalties are allocated to
licenses A and B on a relative standalone selling price basis.
Revenue Recognition at Contract Inception
Assume license A is transferred to the customer three months after contract inception and license B is transferred
at contract inception.
Revenue of $200 is recognized for license A three months after the contract inception when license A is
transferred to the customer.
Revenue of $250 is recognized for license B at contract inception when license B is transferred to the customer.
Recognition of the sales-based royalty allocated to each of the two licenses is deferred to future periods because
ASC 606-10-55-65 precludes the recognition of sales-based royalty before the related sales occur (see Section 7.5
for discussion on licensing).
Although the royalty relates solely to the transfer of license B, the allocation of the fixed consideration ($450) to
license A and the entire sales-based royalties to license B (estimated at $2,250) is disproportionate in comparison
with the standalone selling prices of the two licenses. That is, there is pricing interdependency between the two
licenses, which indicates that some of the royalty generated by license B in fact relates to the sale of license A, and
some of the fixed license fee ($450) stated in the legal contract as relating solely to license A also relates to the
sale of license B.
See Example 7-32 in Chapter 7 (a continuation of this example) for a discussion of the recognition of sales-based
royalties in revenue.
EXAMPLE 5-7: ALLOCATION OF VARIABLE CONSIDERATION — ENTIRELY TO ONE PERFORMANCE OBLIGATION
Assume the same fact pattern in Example 5-5, except that the prices included in the contract are:
License A: a fixed amount of $1,950
License B: a royalty payment of 2.5% of the selling price of the customer’s future sales of products that use
license B
The entity estimates that the amount of sales-based royalties that it will be entitled to in respect of license B will
be about $750.
The entity then considers the criteria in the variable consideration allocation exception to determine the allocation
of the transaction price to each of the two licenses. The entity determines that:
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The variable consideration (sales-based royalty) relates specifically to an outcome from the entity’s performance
obligation to transfer license B (that is, the customer's subsequent sales of products that use that license).
Allocating the expected sales-based royalty amounts of $750 entirely to license B is consistent with the
allocation objective. Although the estimated amount of royalties is less than the standalone selling price of
license B ($1,500), the fixed amount of $1,950 is also greater than the standalone selling price of license A
($1,200). Therefore, the entity concludes that the fixed amount of $1,950 should be allocated to both licenses A
and B after allocating the expected sales-based royalty amounts of $750 entirely to license B.
Allocation of the fixed consideration
The entity allocates the fixed amount of $1,950 to the two licenses based on their standalone selling prices after
allocating the variable amount to license B.
This allocation is calculated as:
Product Allocated Transaction Price
License A ($1,950 x ($1,200/$1,950)) = $1,200
License B ($1,950 x (($1,500-750)/$1,950)) = $750
Total $1,950
TRG DISCUSSIONS — ALLOCATION HIERARCHY — VARIABLE CONSIDERATION AND DISCOUNT
In March 2015, the TRG considered an arrangement that included both variable consideration and a discount and
discussed whether the guidance in ASC 606 on allocating discounts to only one or some (but not all) performance
obligations in a contract is different from the guidance on allocating variable consideration to only one or some (but
not all) performance obligations.
TRG members agreed that ASC 606 establishes a hierarchy for allocating variable consideration, including variable
discounts. When a contract includes variable consideration, an entity first applies the guidance on allocating
variable consideration before considering the guidance on allocating discounts.
TRG members also stated that not all discounts are variable and that if a discount is fixed, that discount does not
give rise to variable consideration. In those cases, an entity would apply the guidance for the allocation of discounts
and not the guidance for the allocation of variable consideration.
REVENUE RECOGNITION UNDER ASC 606 133
BDO INSIGHTS — ALLOCATION OF VARIABLE CONSIDERATION AND DISCOUNT
Some contracts with customers include both variable consideration and a discount that is variable. In that scenario,
a question arises regarding the sequence of applying the guidance on allocation of variable consideration and the
guidance on allocation of discount. Consistent with the TRG discussions above, we believe an entity must first apply
the guidance on variable consideration allocation and then apply the general allocation guidance or the guidance on
allocation of a discount to the remaining amount of the transaction price. An entity first needs to determine
whether the discount is variable consideration. Determining whether a discount is a variable consideration, and its
appropriate allocation, requires the application of professional judgment, based on facts and circumstances.
In the absence of specific guidance in ASC 606, we believe multiple approaches could be acceptable for determining
the amount that represents a discount (rather than variable consideration) and hence is not within the scope of the
guidance on variable consideration allocation. Any approach selected must result in an allocation that is consistent
with the criteria for the variable consideration allocation exception and the allocation objective.
REVENUE RECOGNITION UNDER ASC 606 134
CHAPTER 6 — STEP 5: RECOGNIZE
REVENUE WHEN OR AS THE
PERFORMANCE OBLIGATION IS
SATISFIED
6.1 OVERVIEW
After allocating (in Step 4) the transaction price (determined in Step 3) to the performance obligations identified in the
contract (in Step 2), an entity assesses when it satisfies each performance obligation by transferring a promised good
or service to the customer and recognizes revenue allocated to each performance obligation when (or as) that
performance obligation is satisfied. An entity satisfies its performance obligation in a contract by transferring control
of the promised good or service underlying that performance obligation to the customer, which may be at a point in
time or over time. Therefore, assessing when control of a good or service is transferred to a customer is a critical
aspect of Step 5.
Control in the context of ASC 606 is the ability to direct the use of, and obtain substantially all of the remaining
benefits from, an asset. ASC 606 includes certain indicators to help apply the control principle.
ASC 606 includes three criteria to determine whether a performance obligation is satisfied over time. An entity must
first consider those criteria to determine if a performance obligation is satisfied over time. If none of those criteria are
met, then the performance obligation is satisfied at a point in time. The entity is then required to consider the
indicators of control to determine at what point in time the control transfers to the customer. The following diagram
gives an overview of those requirements:
Presentation
and
Disclosures
Scope
Step 1:
Identify the
contract
with a
customer
Step 2:
Identify the
performance
obligations in
the contract
Step 3:
Determine
the
transaction
price
Step 4:
Allocate the
transaction price to
the performance
obligations
Step 5:
Recognize revenue
when or as the
performance
obligation is
satisfied
Other
Topics
REVENUE RECOGNITION UNDER ASC 606 135
6.2 SATISFACTION OF PERFORMANCE OBLIGATIONS
FASB REFERENCES
ASC 606-10-25-23 through 25-25
An entity recognizes revenue when (or as) it satisfies a performance obligation by transferring a promised good or
service (that is, an asset) to a customer. An asset is transferred to a customer when (or as) the customer obtains
control of that asset. Goods and services are assets, even if only momentarily, when received and used (as in the case
of many services) by customers.
At contract inception, an entity must determine whether it satisfies the performance obligation identified in Step 2
over time or at a point in time. A performance obligation is satisfied at a point in time if an entity does not satisfy the
performance obligation over time.
Over-Time Revenue Recognition Criteria
Note: The over-time revenue recognition criteria need not be
applied in a sequence.
Revenue is
recognized at a point
in time. An entity
determines the point
in time at which
control transfers to
the customer.
Revenue is
recognized over
time. An entity
determines an
appropriate
measure of
progress.
Does the customer simultaneously receive and consume
benefits as the entity performs?
Yes
No
Yes
No
Does the entity’s performance create or enhance an asset
that the customer controls as it is created?
No
Does the entity’s performance create an asset with no
alternative use and the entity has an enforceable right to
payment for performance completed to date?
Yes
REVENUE RECOGNITION UNDER ASC 606 136
BDO INSIGHTS — SEQUENCE FOR DETERMINING WHETHER A PERFORMANCE OBLIGATION IS SATISFIED OVER TIME
OR AT A POINT IN TIME
ASC 606 establishes a sequence for analyzing whether a performance obligation is satisfied at a point in time or over
time. The three criteria in ASC 606-10-25-27 establish whether a performance obligation is satisfied over time (see
Section 6.3 for more discussion). An entity must first evaluate each performance obligation against each of those
criteria to conclude whether a performance obligation is satisfied over time. If none of the over time revenue
recognition criteria are met, then the performance obligation is satisfied at a point in time. An entity cannot omit
the analysis of the over time revenue recognition criteria and default to a conclusion that a performance obligation
is satisfied at a point in time. Rather, to conclude that a performance obligation is satisfied at a point in time, an
entity must first conclude that none of the over time revenue recognition criteria are met.
6.2.1 Notion of Control
FASB REFERENCES
ASC 606-10-25-25 and 25-26 and ASC 606-10-25-30
Control of an asset refers to the ability to direct the use of, and obtain substantially all of the remaining benefits from,
the asset. Control includes the ability to prevent other entities from directing the use of, and obtaining the benefits
from, an asset.
BC120 of ASU 2014-09 states that the description of control in ASC 606 is based on the meaning of control in the
definition of an asset in the FASB’s conceptual framework. The components that make up the description of control are
explained below:
Ability — A customer must have the present right to direct the use of, and obtain substantially all of the remaining
benefits from, an asset for an entity to recognize revenue related to the transfer of that asset to the customer. For
example, in a contract that requires a manufacturer to construct an asset for a particular customer, it might be
clear that the customer will ultimately have the right to direct the use of, and obtain substantially all of the
remaining benefits from, the asset. However, the manufacturer must not recognize revenue until the customer has
obtained that right (which based on the contract, might occur during production or afterwards).
Direct the use of — A customer’s ability to direct the use of an asset refers to the customer’s right to deploy that
asset in its activities, to allow another entity to deploy that asset in its activities, or to restrict another entity from
deploying that asset.
Obtain the benefits from — The customer must have the ability to obtain substantially all of the remaining benefits
from an asset to obtain control of it. The benefits from a good or service are the potential cash flows (either an
increase in cash inflows or a decrease in cash outflows) that can be obtained directly or indirectly, for example by:
• Using the asset to produce goods or provide services (including public services)
• Using the asset to enhance the value of other assets
• Using the asset to settle liabilities or reduce expenses
• Selling or exchanging the asset
• Pledging the asset to secure a loan
• Holding the asset
BC121 of ASU 2014-09 states that the assessment of when control has transferred to a customer could be applied from
the perspective of either the entity selling the good or service or the customer purchasing the good or service.
Therefore, revenue could be recognized when the entity surrenders control of a good or service or when the customer
obtains control of that good or service. Although in many cases both perspectives lead to the same result, the FASB
decided that control must be assessed primarily from the perspective of the customer to minimize the risk of an entity
recognizing revenue from undertaking activities that do not coincide with the transfer of goods or services to the
customer.
REVENUE RECOGNITION UNDER ASC 606 137
ASC 606 provides the following non-exhaustive list of indicators that control has transferred to the customer:
The entity has a present right to payment for the asset.
The customer has legal title to the asset.
The entity has transferred physical possession of the asset.
The customer has the significant risks and rewards of ownership of the asset.
The customer has accepted the asset.
See Section 6.5 for discussion on each of the indicators of control.
REPURCHASE RIGHTS
Additionally, in evaluating whether a customer obtains control of an asset, an entity must consider any agreement
to repurchase the asset, or a component of that asset, transferred to the customer. See Section 6.6 for discussion
on repurchase rights.
BDO INSIGHTS — REVENUE RECOGNITION IS BASED ON TRANSFER OF CONTROL (NOT RISKS AND REWARDS)
Revenue recognition under ASC 606 is based on the transfer of control rather than risks and rewards only. Under the
control model, an analysis of risks and rewards is only one of the many factors considered in determining whether
and when revenue is recognized. Revenue recognition based on the notion of control (rather than risks and rewards)
may significantly affect the timing and pattern of revenue recognition in certain industries.
6.3 PERFORMANCE OBLIGATIONS SATISFIED OVER TIME
FASB REFERENCES
ASC 606-10-25-27
An entity transfers control of a good or service over time and, therefore, satisfies a performance obligation and
recognizes revenue over time, if any one of the following criteria is met:
The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity
performs.
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.
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.
The three criteria provide an objective basis for assessing when control transfers over time and, thus, when a
performance obligation is satisfied over time.
REVENUE RECOGNITION UNDER ASC 606 138
6.3.1 Customer Simultaneously Receives and Consumes Benefits as the Entity Performs
FASB REFERENCES
ASC 606-10-25-27(a), ASC 606-10-55-5 and 55-6
If a customer simultaneously receives and consumes the benefits provided by an entity’s performance as the entity
performs, then the entity transfers control of a good or service underlying a performance obligation to the customer
over time and, therefore, revenue attributed to that performance obligation is recognized over time.
For some types of performance obligations, the analysis 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 is
straightforward. For example, for routine or recurring services, such as a cleaning service, the receipt and
simultaneous consumption by the customer of the benefits of the entity’s performance may be readily identified.
In many typical service contracts, an entity’s performance creates an asset only momentarily because that asset is
simultaneously received and consumed by the customer. In those cases, the simultaneous receipt and consumption of
the asset that has been created means that the customer obtains control of the entity’s output as the entity performs
and thus, the entity’s performance obligation is satisfied over time.
BDO INSIGHTS — ANALYZING WHETHER THE CUSTOMER SIMULTANEOUSLY RECEIVES AND CONSUMES BENEFITS
Although the standard includes cleaning services as an example of a performance obligation satisfied over time,
entities must carefully analyze cleaning contracts to appropriately identify the performance obligation(s) and
determine the pattern of satisfaction of the performance obligation(s) identified. For example, consider a three-
year cleaning contract of an office building in which the windows are cleaned once every six months (and requires
five days to complete), carpets are deep cleaned once a month (and takes place over a weekend), and trash
disposal and vacuuming is done daily outside normal office working hours. In this fact pattern, each cleaning
activity may constitute a separate performance condition, and if so, it would be necessary to allocate the
transaction price to each of the performance obligations. The transaction price allocated to window cleaning and
the deep cleaning of carpets would be recognized as those activities take place (rather than ratably over the three-
year contractual period).
Similarly, in certain industries, such as the airline industry, an entity may provide ongoing maintenance for critical
equipment such as airplane engines, as well as periodic overhaul services. While both the ongoing maintenance and
overhaul services likely meet the criterion to be recognized over time (because the customer simultaneously
receives and consumes the benefits provided by the entity), the entity would likely conclude that the ongoing
maintenance and overhaul services are distinct performance obligations, each with different timing for revenue
recognition. As such, the transaction price must be allocated to the ongoing maintenance activities and overhaul
activities, and the allocated amounts are recognized in revenue as those separate activities take place.
6.3.1.1 Substantial Reperformance of the Performance Completed to Date
FASB REFERENCES
ASC 606-10-55-159 and 55-160
For some types of performance obligations in service-type contracts, 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 because the notion of “benefit” can be subjective. In those circumstances, a performance obligation is
REVENUE RECOGNITION UNDER ASC 606 139
satisfied over time if an entity determines that another entity would not need to substantially reperform the work that
the entity has completed to date if another entity were to fulfill the remaining performance obligation to the
customer.
DETERMINING WHETHER ANOTHER ENTITY WOULD NOT NEED TO SUBSTANTIALLY REPERFORM THE
COMPLETED WORK
In determining whether another entity would not need to substantially reperform the work the entity has completed
to date, an entity must make both of the following assumptions:
Disregard potential contractual restrictions or practical limitations that otherwise would prevent the entity from
transferring the remaining performance obligation to another entity.
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 (for example, a partially completed service or item of
property, plant, and equipment) and that would remain controlled by the entity if the performance obligation
were to transfer to another entity.
BC126 of ASU 2014-09 states that the assessment of whether another entity would need to substantially reperform the
performance completed to date can be used as an objective basis for determining whether the customer receives
benefit from the entity’s performance as it is provided. BC127 of ASU 2014-09 states that an entity disregards any
contractual or practical limitations in assessing whether another entity would need to substantially reperform the
performance completed to date because the objective of the criterion on whether the customer receives benefit from
the entity’s performance as it is provided is to determine whether control of the goods or services has already been
transferred to the customer. This is done by using a hypothetical assessment of what another entity would need to do
if it were to take over the remaining performance requirements. Therefore, actual, practical, or contractual
limitations on the remaining performance have no bearing on the assessment of whether the entity has transferred
control of the goods or services provided to a customer to date.
EXAMPLE 6-1 (ADAPTED FROM ASC 606-10-55-159 AND 55-160): CUSTOMER SIMULTANEOUSLY RECEIVES AND
CONSUMES THE BENEFITS
An entity enters a contract with a customer to provide monthly payroll processing services to a customer for one
year. Assume the promised payroll processing services are accounted for as a single performance obligation in
accordance with the series guidance (see Section 3.4 for discussion on the series guidance).
The performance obligation is satisfied over time because the customer simultaneously receives and consumes the
benefits of the entity’s performance in processing each payroll transaction as and when each transaction is
processed. This is demonstrated by another entity not needing to reperform payroll processing services for the
service that the entity has provided to date.
In performing the above assessment, the entity disregards any practical limitations on transferring the remaining
performance obligation, for example, any setup activities that may be undertaken by another entity.
The entity recognizes revenue over time by measuring its progress toward complete satisfaction of that
performance obligation — see Section 6.4 for discussion on measure of progress.
REVENUE RECOGNITION UNDER ASC 606 140
EXAMPLE 6-2: CUSTOMER SIMULTANEOUSLY RECEIVES AND CONSUMES THE BENEFITS
A shipping entity enters a contract with a customer to transport goods from New York to Rotterdam (Netherlands).
When the entity enters the contract, the ship used to transport the goods is docked in Miami. At the reporting date,
the goods have been collected from New York, and the ship is half-way across the Atlantic Ocean.
The entity concludes that it can recognize revenue for its performance completed to date (that is, transportation of
goods from New York to a location half-way across the Atlantic Ocean) because another entity would not need to re-
perform the transportation services provided to date. In reaching that conclusion, the entity disregards the
practical limitation from a hypothetical transfer of the goods from its ship to another shipping entity’s ship in the
middle of the Atlantic Ocean.
Therefore, the entity recognizes revenue over time by measuring its progress toward complete satisfaction of that
performance obligation — see Section 6.4 for discussion on measure of progress.
BDO INSIGHTS — EXAMPLE 6-2 AND SHIPPING CONTRACTS
Careful analysis of shipping contracts may be required because in some circumstances, those contracts may contain
a lease of the ship used to transport goods because the customer has the right to direct the use of the ship for a
period of time. In those cases, ASC 842 may also apply to the contract (rather than only ASC 606). If a shipping
contract includes services (for example, providing crew for the ship) with the lease of the ship, then the services
would be within the scope of ASC 606 and the lease would be within the scope of ASC 842.
8
However, if the shipping
contract does not include the transfer of a good or service within the scope of ASC 606, then the entire contract
would be accounted for as a lease under ASC 842 (that is, no part of the contract would be within the scope of
ASC 606). If the arrangement is accounted for under ASC 842, lease income (assuming the lease is classified as an
operating lease under ASC 842) would be recognized from the date of lease commencement (that is, right to direct
the use of the ship passes to the customer), which could result in lease income being recognized as the ship sails
from Miami to New York.
If the contract does not contain a lease and is instead accounted for as a promise to provide shipping services under
ASC 606, revenue is not recognized to reflect the effort required to move the ship from Miami, its location at
contract inception, to New York because the shipping entity does not provide any service to the customer during
that part of the overall journey. Rather, the entity recognizes revenue at the reporting date to reflect the extent to
which the goods have been transported from New York to Rotterdam. Additionally, the entity must consider
whether the costs for the journey from Miami to New York represent costs to fulfill the contract that is accounted
for under ASC 340-40 (see Section 7.7 for discussion on contract costs).
8
ASC 842-10-15-42A provides a lessor an accounting policy election to combine certain non-lease components (such as services)
within the scope of ASC 606 with a lease component in a contract and account for the combined component under ASC 606 or
ASC 842 based on whether the lease or non-lease component is predominant. See our Blueprint, Accounting for Leases Under
ASC 842, for guidance on ASC 842.
REVENUE RECOGNITION UNDER ASC 606 141
TRG DISCUSSIONS — TRANSFER OF CONTROL — COMMODITIES
In July 2015, the TRG discussed whether the control of a commodity (such as gas, electricity, or heating oil) is
transferred at a point in time or over time.
The TRG members generally agreed that all known facts and circumstances must be considered when determining
whether a customer simultaneously receives and consumes the benefits of a commodity. These facts and
circumstances might include, for example, the following:
Contract terms
Customer infrastructure
Whether or not the commodity can be stored
Therefore, depending on the facts and circumstances surrounding the sale of commodity, revenue may or may not
be recognized over time. For example, a performance obligation to provide natural gas to a residential location on
an as-needed basis would likely meet the over time revenue recognition criterion on whether the customer
simultaneously receives benefits from the entity’s performance as the entity performs because the residential
household likely would not have the ability to store gas and instead would pay for any gas that is delivered as it is
used. Conversely, a contract to deliver a fixed amount of natural gas to a reseller of that gas would likely not meet
that over time revenue recognition criterion because the contract includes a fixed amount of gas to be delivered,
and the customer/reseller would likely have the intent and ability to store the gas until it is resold to an end
consumer.
BC128 of ASU 2014-09 states that the over time revenue recognition criterion on whether the customer simultaneously
receives benefits from the entity’s performance as the entity performs is not intended to apply to contracts in which
the entity’s performance is not immediately consumed by the customer, which would be typical in cases when the
entity’s performance results in an asset such as work in process in a construction contract. If an entity applies ASC 606
to contracts in which the entity’s performance results in an asset (which could be tangible or intangible) being created
or enhanced, it considers the other two over time revenue recognition criteria — see Sections 6.3.2 and 6.3.3. for
related discussion.
6.3.2 Performance Creates or Enhances an Asset That the Customer Controls As It Is Created
FASB REFERENCES
ASC 606-10-25-27(b) and ASC 606-10-55-7
If an entity’s performance creates or enhances an asset (for example, work in process) that the customer controls as
the asset is created or enhanced, then the entity transfers control of a good or service underlying a performance
obligation to the customer over time and, therefore, revenue attributed to that performance obligation is recognized
over time. In those cases, because the customer controls any work in process, the customer is obtaining the benefits of
the goods or services that the entity is providing and, thus, the performance obligation is satisfied over time.
To determine whether a customer controls an asset that is being created or enhanced by an entity’s performance as it
is created or enhanced, an entity must apply the guidance on control, including considering whether the indicators of
control are met related to any work in process as the promises are being delivered. See Section 6.2.1 for discussion on
the notion of control.
The asset being created or enhanced by an entity could be either tangible or intangible, for example, a building that is
being constructed by an entity on land owned by the customer, or customized software being integrated into a
customer’s existing IT infrastructure.
REVENUE RECOGNITION UNDER ASC 606 142
BC130 of ASU 2014-09 states that the basis for the over time revenue recognition criterion on whether an entity’s
performance creates or enhances an asset that the customer controls is consistent with the rationale underlying the
percentage-of-completion revenue recognition approach in the prior revenue recognition guidance. That prior guidance
acknowledged that in many construction contracts, the entity in effect agrees to sell its rights to the asset (that is,
work in process) as the entity performs, which effectively results in a continuous sale (that is, the customer controls
the work in process) that occurs as the work progresses.
The criterion on whether an entity’s performance creates or enhances an asset that the customer controls is most
likely relevant when a customer clearly controls the asset as it is created or enhanced, for example, when an asset is
being constructed by an entity on the customer’s premises. For some performance obligations, it may be unclear
whether the asset that is created or enhanced is controlled by the customer. In those cases, it can be more challenging
to determine when control transfers. Therefore, the standard includes the third over time revenue recognition
criterion — see Section 6.3.3 for related discussion.
BDO INSIGHTS — ANALYSIS OF OVER TIME REVENUE RECOGNITION CRITERIA IN CONTRACTS WITH THE U.S.
FEDERAL GOVERNMENT
Contracts with the U.S. federal government under Federal Acquisition Regulations (FAR) generally require analysis
under the over time revenue recognition criteria in ASC 606-10-25-27(b) and 25-27(c) (that is, the criterion on
whether an entity’s performance creates or enhances an asset that the customer controls and the criterion on
whether an entity’s performance creates an asset with no alternative use to the entity and the entity has an
enforceable right to payment for performance created to date).
Contracts governed by FAR generally include termination clauses that provide the federal government with the right
to obtain any work in process throughout the contract period if the contract is terminated before completion. The
customer’s ability to terminate the contract and obtain the interim work product is an indicator of control that
must be analyzed with other rights, such as rights to payment, legal title, but which often results in meeting the
criterion that an entity’s performance creates or enhances an asset that the customer controls.
Contracts governed by FAR may also contain substantive contractual restrictions that prevent an entity from
redirecting completed products to another entity if the contract with the federal government is terminated. The
entity also typically has an enforceable right to payment for performance completed to date under the standard
FAR payment terms, resulting in those contracts meeting the criterion that an entity’s performance creates an asset
with no alternative use to the entity and the entity has an enforceable right to payment for performance created to
date. See Section 6.3.3. for discussion on the over time revenue recognition criterion.
6.3.3 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
FASB REFERENCES
ASC 606-10-25-27(c)
If an 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 created to date, then the entity transfers control of a good or service
underlying a performance obligation to the customer over time and, therefore, revenue attributed to that performance
obligation is recognized over time.
BC132 of ASU 2014-09 states that the application of the two over time revenue recognition criteria discussed in
Sections 6.3.1 and 6.3.2 could be challenging in some fact patterns and, therefore, provided the third criterion to help
with the assessment of control. The FASB observed that this criterion may be necessary for services that are specific to
a customer (for example, consulting services that ultimately result in a professional opinion specifically for the
customer) as well as for the creation of tangible or intangible goods.
REVENUE RECOGNITION UNDER ASC 606 143
This criterion consists of two sub-criteria:
No “alternative use”
An enforceable “right to payment”
BC142 of ASU 2014-09 explains why the assessment of control in this criterion requires both no “alternative use” and a
“right to payment.” Specifically, if an asset that an entity is creating does not have an alternative use to the entity,
then the entity is effectively constructing an asset at the direction of the customer. Therefore, the entity will want to
be economically protected from the risk of the customer terminating the contract and leaving the entity with no asset
or an asset that has little value to the entity. That protection will be established by requiring the customer to pay for
the entity’s performance completed to date if the contract is terminated before completion. Therefore, the fact that
the customer is obligated to pay for the entity’s performance (or, in other words, is unable to avoid paying for that
performance) implies that the customer has obtained the benefits from the entity’s performance. This is consistent
with other exchange contracts when a customer is typically be obligated to pay only if it has received control of goods
or services in the exchange. The notions of “alternative use” and “right to payment” are discussed in Sections 6.3.3.1
and 6.3.3.2.
6.3.3.1 Performance Does Not Create an Asset With an Alternative Use
FASB REFERENCES
ASC 606-10-25-28, ASC 606-10-55-8 and 55-9
An asset created by an entity’s performance does not have an alternative use to an entity if either of the following
applies:
The entity is restricted contractually from readily directing the asset for another use during the creation or
enhancement of that asset.
The entity is limited practically from readily directing the asset in its completed state for another use.
At contract inception, an entity must assess whether the asset in its completed form has an alternative use to the
entity. After contract inception, an entity does not update the assessment of the alternative use of an asset unless the
parties to the contract approve a contract modification that substantively changes the performance obligation (see
Section 7.3 for discussion on accounting for contract modifications). BC140 of ASU 2014-09 states that the requirement
to assess alternative use at contract inception only is intended to avoid a continual reassessment of whether the asset
has an alternative use, which could lead to a pattern of performance (and, therefore, revenue recognition) that is not
useful.
CONTRACTUAL RESTRICTIONS AND PRACTICAL LIMITATIONS
Additionally, in assessing whether an asset has an alternative use to an entity, an entity must consider the effects
of contractual restrictions and practical limitations on the entity’s ability to readily direct that asset for another
use, such as selling it to a different customer. However, the possibility of the contract with the customer being
terminated is not relevant in assessing whether the entity would be able to readily direct the asset for another use.
6.3.3.1.1 Substantive Contractual Restriction
A contractual restriction on an entity’s ability to direct an asset for another use must be substantive for the asset to
have no alternative use to the entity.
A contractual restriction is substantive if a customer could enforce its rights to the promised asset if the entity
sought to direct the asset for another use.
REVENUE RECOGNITION UNDER ASC 606 144
A contractual restriction is not substantive if, for example, an asset is largely interchangeable with other assets that
the entity could transfer to another customer without breaching the contract and without incurring significant costs
that otherwise would not have been incurred in relation to that contract. This might apply when the asset being
sold is mass produced, and it would be straightforward to substitute an equivalent item for a particular item subject
to an existing contract, with the original item being sold to another customer. This would apply even if each of the
items produced could be specified individually by each customer from a range of options because it is
straightforward to produce another item with the same options and, therefore, meet the requirements of a
particular contract.
EXAMPLE 6-3: SUBSTANTIVE CONTRACTUAL RESTRICTION — SALE OF REAL ESTATE
A contract for the sale of real estate with a contractual restriction on the seller’s ability to direct an asset for
another use is typically considered substantive if the seller is prohibited from selling the asset to another customer.
For example, a seller typically cannot substitute a different condominium unit for the one contracted for by the
customer, even if the two condominium units are substantially the same, as might be the case for two condominium
units with identical floor plans in the same building.
EXAMPLE 6-4: CONTRACTUAL RESTRICTION IS NOT SUBSTANTIVE — SALE OF A CAR
Generally, a contract for the sale of a car with customer-specific customizations (exterior color, wheels, interior
finishes, etc.) does not include a substantive contractual restriction on the seller’s ability to direct that car for
another use, for example, by selling that car to another customer. Even if the contract prohibited selling the car to
another customer, each car produced could be customized by each customer from a range of optional extras and
the seller could produce another car with the same options without incurring significant costs to meet the
requirements of a particular contract.
CONTRACTUAL RESTRICTIONS THAT PROVIDE A PROTECTIVE RIGHT TO THE CUSTOMER
Contractual restrictions that provide a protective right to the customer are not sufficient to establish that an asset
has no alternative use to the entity. BC138 of ASU 2014-09 states that a protective right typically results in the
entity having the practical ability to physically substitute or redirect the asset without the customer’s awareness of
or objections to the change. Consider an example in which a contract states that an entity cannot transfer a good
because a customer has legal title to the goods in the contract. However, the customer’s legal title to the goods is
intended to protect the customer in the event of the entity’s liquidation, and the entity can physically substitute
and redirect the goods to another customer for little cost. In that example, the contractual restriction is merely a
protective right and does not indicate that control of the goods has transferred to the customer.
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6.3.3.1.2 Practical Limitation
FASB REFERENCES
ASC 606-10-55-10
A practical limitation on an entity’s ability to direct an asset for another use exists if an entity would incur significant
economic losses to direct the asset for another use. A significant economic loss could arise because the entity would
either incur significant costs to rework the asset or only be able to sell the asset at a significant loss. For example, an
entity may be practically limited from redirecting assets that either have customer-specific design specifications or are
located in remote areas.
BC134 through BC138 of ASU 2014-09 explain further the concept of “alternative use” and how to consider whether a
contractual or practical restriction exists. First, the notion of “alternative use” was developed to exclude the
circumstances in which an entity’s performance would not result in the transfer of control of goods or services to the
customer over time. Specifically, when the entity’s performance creates an asset with an alternative use to the entity,
for example a standard inventory-type item that could be used to fulfil different contracts with different customers,
the entity could readily direct the asset to another customer. In those cases, the customer cannot control the asset as
it is being created because absent any contractual restrictions, the customer does not have the ability to restrict the
entity from directing that asset to another customer.
Further, when an entity creates an asset that is highly customized for a specific customer, the asset would be less
likely to have an alternative use to the entity because the entity would incur significant costs to reconfigure the asset
for sale to another customer or would need to sell the asset for a significantly reduced price. In that case, the
customer could be regarded as receiving the benefit of that performance and, as a result, having control of the goods
or services (that is, the asset being created) as the performance occurs if the entity also has a right to payment (see
Section 6.3.3.2 for related discussion).
In addition, although the level of customization might be a helpful factor to consider in assessing whether an asset has
an alternative use, it is not a determinative factor. This is because in some cases (for example, some real estate
contracts), an asset may be standardized but still might have no alternative use to an entity because of substantive
contractual restrictions that prevent the entity from readily directing the asset to another customer. If a contract
precludes an entity from transferring an asset to another customer and that restriction is substantive, the entity does
not have an alternative use for that asset because it is legally obligated to direct the asset to the customer. This fact
indicates that the customer controls the asset as it is created because the customer has the present ability to restrict
the entity from directing that asset to another customer if the entity also has a right to payment (see Section 6.3.3.2
for related discussion).
In determining whether the entity is limited practically from directing the asset for another use, an entity should
consider the characteristics of the asset that will ultimately be transferred to the customer. This is because, for some
assets, the critical factor in making the assessment is whether the asset that is ultimately transferred could be
redirected without a significant cost of rework rather than the period of time for which the asset has no alternative
use. This may be relevant in some manufacturing contracts in which the basic design of the asset is the same across
multiple contracts, but the customization in each contract is substantial. Therefore, redirecting the asset from one
contract in its completed state to another customer requires significant rework.
Requiring an entity to consider contractual and practical restrictions is seemingly contradictory to the requirement to
ignore contractual and practical limitations when applying the over-time revenue recognition criterion on whether the
customer simultaneously receives benefits from the entity’s performance as the entity performs (see Section 6.3.1). In
BC139 of ASU 2014-09, the FASB stated that this difference is appropriate and added that although the objective of
both criteria is to assess when control transfers over time, each criterion provides a different method for assessing
when that control transfers because the criteria were designed to apply to different scenarios.
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EXAMPLE 6-5: (ADAPTED FROM ASC 606-10-55-165 THROUGH 55-168) — ASSET HAS NO ALTERNATIVE USE TO
THE ENTITY
An entity builds satellites for various customers, such as governments and commercial entities. The design and
construction of each satellite differ substantially, based on each customer’s needs and the type of technology that
is incorporated into the satellite.
The entity enters a contract with a customer to build a specialized satellite. The contract does not preclude the
entity from directing the completed satellite to another customer. Assume that the entity’s sole performance
obligation in the contract is to build the satellite.
The entity assesses at contract inception whether its performance obligation to build the satellite is satisfied over
time. The entity observes that although the contract does not preclude the entity from directing the completed
satellite to another customer, the entity would incur significant costs to rework the design and function of the
satellite to direct that specific satellite to another customer. As a result, the entity determines that the satellite
built for the customer has no alternative use to the entity because the customer-specific design of the satellite
limits the entity’s practical ability to readily direct the satellite to another customer.
EXAMPLE 6-6: ASSET IN ITS COMPLETED FORM HAS NO ALTERNATIVE USE TO THE ENTITY
A manufacturing entity manufactures metal pipe fittings for industrial use. The entity manufactures generic pipe
fittings for off-the-shelf sales and customized pipe fittings for the specialized needs of a specific customer. The
entity often uses a generic pipe fitting to customize it according to a customer’s specifications. The entity is unable
to sell a customized pipe fitting to other customers.
The entity enters a contract with a customer to manufacture a customized pipe fitting. The contract does not
preclude the entity from directing the customized pipe fitting to another customer. The basic design of the
customized pipe fitting (for example, metal type, shape, etc.) is the same as for a generic pipe fitting.
Assume that the entity’s sole performance obligation in the contract is to manufacture a customized pipe fitting.
The entity assesses at contract inception whether its performance obligation to manufacture a customized pipe
fitting is satisfied over time. Because the basic design of the specialized pipe fitting is the same as for a generic
pipe fitting, the entity can redirect the work in process (asset) to another customer or for another purpose until the
customization begins in the manufacturing process. In other words, the asset remains generic and interchangeable
up to a certain point in the manufacturing process. However, the completed asset (the customized pipe fitting)
cannot be sold to another customer and redirecting it to another customer or redirecting it for another purpose
would require significant rework.
Therefore, the entity determines that the customized pipe fitting (that is, the asset in its completed form) has no
alternative use to the entity regardless of the following:
The asset is generic and can be redirected to another customer or for another purpose up to a certain point in
the manufacturing process.
The entity is not contractually precluded from directing the specialized pipe fitting to another customer.
Assuming the entity has an enforceable right to payment for performance completed to date (see Section 6.3.3.2
for related discussion), the performance obligation for the customized pipe fitting is satisfied over time, and the
entity recognizes revenue over time during the manufacturing process. However, the entity begins to recognize
revenue only when the customization begins in the manufacturing process. Before the customization begins, the
entity’s performance does not transfer an asset to the customer but rather creates an asset (inventory) for the
entity. See Section 6.4 for discussion on measure of progress for recognizing revenue.
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6.3.3.2 The Entity Has an Enforceable Right to Payment for Performance Completed to Date
FASB REFERENCES
ASC 606-10-25-27(c) and ASC 606-10-25-29
Concluding that an asset has no alternative use is not sufficient to conclude that a customer controls an asset as it is
being constructed. Rather, an entity must also have an enforceable “right to payment” for performance completed to
date to demonstrate that a customer controls an asset that has no alternative use as it is being created.
EVALUATING ENFORCEABLE RIGHT TO PAYMENT FOR PERFORMANCE COMPLETED TO DATE
An entity must consider the terms of the contract, as well as any applicable laws, when evaluating whether it has
an enforceable right to payment for performance completed to date.
While the right to payment for performance completed to date need not be for a fixed amount, the entity must be
entitled to an amount that at least compensates the entity for performance completed to date at all times
throughout the duration of the contract if the contract is terminated by the customer or another party for reasons
other than the entity’s failure to perform as promised.
6.3.3.2.1 Amount That at Least Compensates the Entity for Performance Completed to Date
FASB REFERENCES
ASC 606-10-55-11
An amount that compensates an entity for performance completed to date would be an amount that approximates the
selling price of the goods or services transferred to date (for example, recovery of the costs incurred by an entity in
satisfying the performance obligation plus a reasonable profit margin) rather than compensation for only the entity’s
potential loss or profit if the contract was terminated.
REASONABLE PROFIT MARGIN
Compensation for a reasonable profit margin need not equal the profit margin expected if the contract was fulfilled
as promised. However, an entity must be entitled at all times throughout the contract duration to compensation for
either of the following amounts:
A proportion of the expected profit margin in the contract that reasonably reflects the extent of the entity’s
performance under the contract before termination by the customer (or another party)
A reasonable return on the entity’s cost of capital for similar contracts (or the entity’s typical operating margin
for similar contracts) if the contract-specific margin is higher than the return the entity usually generates from
similar contracts
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BDO INSIGHTS — CONTRACTS PRICED AT LOSS AT CONTRACT INCEPTION
Sometimes contracts with customers are priced at a loss at contract inception. ASC 606-10-55-11 uses the term
“reasonable profit margin” to describe what would constitute the amount that would at least compensate an entity
for performance completed to date. We believe “reasonable profit margin” could be interpreted as the applicable
loss margin in a contract that is priced at a loss at contract inception. If an entity is entitled to a proportionate
amount of the transaction price (even if it is priced at loss) for performance completed to date at all times
throughout the contract duration, then the entity is entitled to an amount that would at least compensate it for
performance completed to date. See Section 7.6 for a discussion of onerous contracts.
BC143 of ASU 2014-09 states the FASB’s intent that the term “right to payment” refers to a payment that compensates
an entity for its performance completed to date rather than, for example, a payment of a deposit or a payment to
compensate the entity for inconvenience or loss of profit. The underlying objective of the third over time revenue
recognition criterion (whether an entity’s performance creates an asset with no alternative use to the entity and the
entity has an enforceable right to payment for performance created to date) is to determine whether the entity is
transferring control of goods or services to the customer as an asset is being created for that customer. Therefore,
assuming rational behavior by the seller and no broader perceived economic benefits that might exist outside the scope
of the contract with the customer, the seller would only agree to transfer control of the goods or services to the
customer if the seller is compensated for the costs from fulfilling the contract and it receives a profit margin that
includes a return on those costs.
BC144 of ASU 2014-09 further states that the compensation to which the entity would be entitled upon termination by
the customer might not always be the contract margin because the value transferred to a customer in a prematurely
terminated contract may not be proportional to the value if the contract was completed. However, to demonstrate
compensation for performance completed to date, the compensation must be either:
Based on a reasonable proportion of the entity’s expected profit margin
Represent a reasonable return on the entity’s cost of capital
Furthermore, in analyzing the compensation to which the entity would be entitled upon termination by the customer,
the focus must be on the amount to which the entity would be entitled upon termination rather than the amount for
which the entity might ultimately be willing to settle in a negotiation.
6.3.3.2.2 Existence and Enforceability of Right to Payment
FASB REFERENCES
ASC 606-10-55-12 through 55-15
An entity’s right to payment for performance completed to date need not be a present unconditional right to payment.
In many cases, an entity could have an unconditional right to payment only at an agreed-upon milestone or upon
complete satisfaction of the performance obligation. In assessing whether it has a right to payment for performance
completed to date, an entity must consider whether it would have an enforceable right to demand or retain payment
for performance completed to date if the contract was terminated before completion for reasons other than the
entity’s failure to perform as promised.
In BC145 of ASU 2014-09, the FASB clarified that an entity need not have a present unconditional right to payment.
Instead, it must have an enforceable right to demand and retain payment for performance completed to date if the
customer were to terminate the contract without cause before completion because the contractual payment terms
might not always align with an entity’s enforceable rights to payment for performance completed to date. For
example, consider a contract in which a consulting entity agrees to provide a report at the end of the contract for a
fixed amount that is conditional on providing that report. If the consulting entity were performing under that contract,
it would have a right to payment for performance completed to date if the contractual terms or local laws require the
REVENUE RECOGNITION UNDER ASC 606 149
customer to compensate the entity for work completed to date if the customer terminates the contract without cause
before completion.
In some contracts, a customer may have a right to terminate the contract only at specified times during the contract
term, or the customer may not have any right to terminate the contract. If a customer acts to terminate a contract
without having the right to terminate the contract at that time (including when a customer fails to perform its
obligations as promised), the contract (or other laws) might entitle the entity to continue to transfer to the customer
the goods or services promised in the contract and require the customer to pay the contractually agreed consideration
in exchange for those goods or services. In those situations, an entity has a right to payment for performance
completed to date because the entity has a right to continue to perform its obligations in accordance with the contract
and to require the customer to perform its obligations which include paying the promised consideration. This would be
the case if the contract or other local laws require the entity and the customer to complete their respective
obligations (often referred to as specific performance).
ASSESSMENT OF A RIGHT TO PAYMENT MAY EXTEND BEYOND THE CONTRACTUAL TERMS
In assessing the existence and enforceability of a right to payment for performance completed to date, an entity
must consider the contractual terms as well as any legislation or legal precedent that could supplement or override
those contractual terms. This may include assessing whether:
Legislation, administrative practice, or legal precedent confers upon the entity a right to payment for
performance completed to date even if that right is not contractually specified.
Relevant legal precedent indicates that similar rights to payment for performance completed to date in similar
contracts have no binding legal effect.
An entity’s customary business practices of choosing not to enforce a right to payment has resulted in the right
being rendered unenforceable in that legal environment. However, notwithstanding that an entity may choose to
waive its right to payment in similar contracts, an entity would continue to have a right to payment to date if, in
the contract with the customer, its right to payment for performance to date remains enforceable.
ASSESSMENT OF ENFORCEABLE RIGHT TO PAYMENT — PAYMENT SCHEDULE
A payment schedule and other related information specified in a contract do not necessarily indicate whether an
entity has an enforceable right to payment for performance completed to date. Although the contractually
specified payment schedule and related information identify the timing and amount of consideration that is payable
by a customer, the payment schedule and related information might not necessarily provide evidence of the entity’s
right to payment for performance completed to date. For example, a contract with a payment schedule could
specify that the consideration received from the customer is refundable for reasons other than the entity failing to
perform as promised in the contract. In addition, a payment schedule may not adequately compensate an entity for
work performed at all points during the contract.
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ASSESSMENT OF ENFORCEABLE RIGHT TO PAYMENT — 100% NONREFUNDABLE UPFRONT PAYMENT
BC146 of ASU 2014-09 includes discussion on whether a 100% nonrefundable upfront payment would meet the “right
to payment for performance completed to date” criterion because a 100% payment would at least compensate the
entity for work completed to date throughout the contract. This type of payment would meet the “right to payment
for performance completed to date” criterion if the entity had an enforceable right to retain (and not refund) that
payment if the customer terminated the contract; otherwise, it is questionable whether the entity actually has a
right to payment.
In addition, different countries and sub-national jurisdictions may provide entities with legal rights that are applicable
but are not explicitly included in the contracts. For example, a contract might refer to compliance with applicable
laws but not specify precisely what these laws are. Therefore, in the absence of contractually specified terms that
provide evidence of an enforceable right to payment for performance completed to date, an entity may need to review
relevant legal precedence in its jurisdiction.
BDO INSIGHTS — ANALYZING RIGHT TO PAYMENT WHEN CONTRACT TERMS ARE SILENT
We generally believe if a contract’s written terms do not specify the entity’s right to payment upon contract
termination, an enforceable right to payment is presumed not to exist. This is based on the following interpretation
from the FASB staff at the Private Company Council meeting held on June 26, 2018:
“The staff understands that questions have arisen about how to handle contracts in circumstances in which the
entity creates a good with no alternative use and the contract with the customer does not specify by its written
terms the entity’s right to payment upon contract termination. Some stakeholders have asked whether it was the
FASB’s intent that companies analyze every law in every jurisdiction to determine whether there is recoverability.
In the staff’s view, a reasonable interpretation of the guidance is that when a contract’s written terms do not
specify the entity’s right to payment upon contract termination, an enforceable right to payment is presumed not
to exist.”
9
However, there may be circumstances in which an enforceable right to payment exists even though the contract is
silent as to such rights. If an entity asserts that it has such rights, we believe the entity must support its assertion
with legislation, administrative practice, or legal precedence confirming that an enforceable right to payment exists
in the relevant jurisdiction. The fact that the entity would have a basis for making a claim against the counterparty
in a court of law would not be sufficient to support that an enforceable right to payment exists.
9
FASB Staff Private Company Council Memo, Definition of an Accounting Contract and Short Cycle Manufacturing (Right
to Payment).
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EXAMPLE 6-7 (ADAPTED FROM ASC 606-10-55-161 THROUGH 55-164): ASSESSING ALTERNATIVE USE AND RIGHT
TO PAYMENT
An entity enters a contract with a customer to provide a consulting service to the customer. The service will result
in the entity providing a professional opinion related to customer-specific facts and circumstances. If the customer
terminates the contract for reasons other than the entity’s failure to perform as promised, the customer is
contractually required to compensate the entity for its costs incurred plus a 15% margin, which approximates the
profit margin that the entity earns from similar contracts.
The entity assesses at contract inception whether its performance obligation to provide a consulting service with a
professional opinion is satisfied over time.
The entity then evaluates the criterion on whether the entity’s performance creates an asset with no alternative
use to the entity and the entity has an enforceable right to payment for performance completed to date. The entity
determines that criterion is met because of both of the following factors:
The development of the professional opinion creates an asset with no alternative use to the entity because the
professional opinion relates to customer-specific facts and circumstances. Therefore, there is a practical
limitation on the entity’s ability to readily direct the asset to another customer.
The entity has an enforceable right to payment for its performance completed to date for its costs plus a
reasonable margin, which approximates the profit margin in other contracts.
Therefore, the entity determines that its performance obligation is satisfied over time and recognizes revenue over
time. See Section 6.4 for discussion on measure of progress.
EXAMPLE 6-8 (ADAPTED FROM ASC 606-10-55-169 THROUGH 55-172): ENFORCEABLE RIGHT TO PAYMENT FOR
PERFORMANCE COMPLETED TO DATE
An entity enters a contract with a customer to build an item of equipment based on the customer’s unique
specifications. The contractually stated payment schedule requires the customer to make payments as follows:
An advance payment of 10% of the contract price at contract inception
Regular payments throughout the construction period amounting to 50% of the contract price
A final payment of 40% of the contract price after construction is complete and the equipment has passed the
prescribed performance tests
The payments are nonrefundable unless the entity fails to perform as promised. The entity is entitled to retain any
progress payments received from the customer if the customer terminates the contract before completion. The
entity has no further rights to compensation from the customer.
The entity assesses at contract inception whether its performance obligation to build the equipment is satisfied
over time. Because the equipment is constructed to the customer’s unique specifications, the entity concludes that
the equipment has no alternative use.
As part of that assessment, the entity considers whether the entity has an enforceable right to payment for
performance completed to date if the customer were to terminate the contract for reasons other than the entity’s
failure to perform as promised. The entity observes that it has the right to receive nonrefundable payments from
the customer at various times during the contract term. However, the cumulative amount of those payments is not
expected to at least correspond to the amount that would be necessary to compensate the entity for performance
completed to date at all points throughout the contract term. Instead, the cumulative amount of consideration paid
by the customer at various times during the contract term might be less than the selling price of the partially
completed item of equipment at that time. Therefore, the entity determines that it does not have a right to
payment for performance completed to date for the duration of the contract.
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Because the entity does not have a right to payment for performance completed to date, the entity’s performance
obligation is not satisfied over time in accordance with the criterion on whether an entity’s performance creates an
asset with no alternative use to the entity and the entity has an enforceable right to payment for performance
created to date.
Assume that the entity also concludes that it does not meet the other two over time revenue recognition criteria
(see Sections 6.3.1 and 6.3.2). Thus, the entity’s performance obligation is not satisfied over time and the entity
accounts for the construction of the equipment as a performance obligation satisfied at a point in time — see
Section 6.5 for discussion on performance obligations satisfied at a point in time.
EXAMPLE 6-9: ENFORCEABLE RIGHT TO PAYMENT
A manufacturing entity entered a contract with a customer to produce a highly specialized good that has no
alternative use to the entity because it is prohibited from selling that product to another customer. The customer
commits to purchase a certain volume of the goods over the contract term because it needs a continuous supply of
the product to avoid interruptions to its production process.
The contract includes the following terms:
The customer must compensate the entity for an amount equal to all costs incurred by the entity to date plus an
agreed upon margin if the customer terminates the contract without cause.
Payment by the customer is due upon delivery of the product.
Goods are shipped under free on board (FOB) destination terms* to the customer’s international premises, and
the entity insures the shipment against potential losses and damages that might affect the goods. Therefore, the
customer will not pay for the products before delivery.
Shipment timing averages 30 days from the entity’s warehouse to the customer’s international premises.
The entity determines that its performance obligation in the contract to manufacture and supply the goods does not
meet the over time recognition criteria in Sections 6.3.1 and 6.3.2 because:
The customer does not consume the economic benefits of the goods while the entity is producing the goods.
The customer does not control the goods while they are in production because among other factors, the entity is
producing the goods on the entity’s premises.
The entity considers whether it has an enforceable right to payment for performance completed to date and
concludes that it has a contractual right to recover all costs incurred plus an appropriate margin at all times
throughout the contract’s duration. Therefore, the entity has a present right to payment for any production
completed to date.
The entity also considers that the customer has no obligation to pay in the event that goods are lost or damaged
during the shipping period but concludes that failure by the entity to complete its contractual obligations because
the goods are lost or damaged during the shipping period does not mean that the entity does not have an
enforceable right to payment for performance completed to date. The possibility that an entity might not perform
its contractual obligations is not relevant to the analysis of whether a performance obligation is satisfied over time.
Additionally, we believe that if there were a significant risk that an entity might not be able to perform its
contractual obligations such that it would not be entitled to payment, then it might not be able to conclude that
collection of substantially all of the consideration is probable, and hence, a contract may not exist for accounting
purposes in Step 1 — see Section 2.2 for related discussion.
*Under FOB destination terms, the buyer takes delivery of goods being shipped by a supplier once the goods arrive
at the buyer's receiving dock.
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EXAMPLE 6-10 (ADAPTED FROM ASC 606-10-55-173 THROUGH 55-182): ASSESSING WHETHER A PERFORMANCE
OBLIGATION IS SATISFIED AT A POINT IN TIME OR OVER TIME — ENTITY DOES NOT HAVE AN ENFORCEABLE RIGHT
TO PAYMENT FOR PERFORMANCE COMPLETED TO DATE
An entity is developing a multi-unit residential complex and enters a binding sales contract with a customer for a
specified unit that is under construction. Each unit in the complex has a similar floor plan and is similar in size but
has certain other attributes that are different (for example, the location of the unit within the complex).
The customer pays an upfront deposit upon entering the contract. The remainder of the price is payable upon
contract completion when the customer obtains physical possession of the unit.
The following terms apply to the upfront deposit:
The entity must refund the deposit to the customer only if the entity fails to complete construction of the unit in
accordance with the contract, but the entity has the right to retain the deposit if the customer defaults on the
contract before completion of the unit
The deposit represents only 20% of the purchase price
The entity assesses at contract inception whether its promise to construct and transfer the unit to the customer is a
performance obligation satisfied over time and observes the following:
It has a right to the upfront deposit only until the construction of the unit is complete, at which time the
remainder of the purchase price is due. If the customer terminates the contract, they forfeit the deposit but are
not obligated to make any additional payments.
The upfront deposit is not sufficient to provide a profit margin at all points during the contract.
Therefore, the entity determines that it does not have an enforceable right to payment for work completed to date.
Accordingly, the entity’s performance obligation is not a performance obligation satisfied over time. Since none of
the other over time revenue recognition criteria are met, the entity accounts for the sale of the unit as a
performance obligation satisfied at a point in time — see Section 6.5 for discussion on performance obligations
satisfied at a point in time.
EXAMPLE 6-11 (ADAPTED FROM ASC 606-10-55-173 THROUGH 55-182): ASSESSING WHETHER A PERFORMANCE
OBLIGATION IS SATISFIED AT A POINT IN TIME OR OVER TIME - ENTITY HAS AN ENFORCEABLE RIGHT TO PAYMENT
FOR PERFORMANCE COMPLETED TO DATE
Assume the same facts in Example 6-10 except the customer pays a nonrefundable deposit upon entering the
contract and must make progress payments during construction of the unit. Substantive contractual terms preclude
the entity from being able to direct the unit to another customer. Additionally, the customer does not have the
right to terminate the contract unless the entity fails to perform as promised.
The following payment terms and local laws are applicable:
If the customer defaults on its obligations by failing to make the promised progress payments, the entity has a
right to all of the consideration promised in the contract if it completes the construction of the unit.
The local courts have previously upheld similar rights that entitle builders to require the customer to perform,
subject to the builder meeting its obligations under the contract.
The entity determines at contract inception that its promise to construct and transfer the unit to the customer is a
performance obligation satisfied over time because:
The unit (asset) created by the entity’s performance has no alternative use to the entity because the contract
precludes the entity from transferring that specified unit to another customer. The entity does not consider the
possibility of a contract termination in assessing whether the entity can direct the asset to another customer.
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The contractual terms and practices in the legal jurisdiction indicate that the entity has a right to payment for
performance completed to date. This is because if the customer were to default on its obligations, the entity has
an enforceable right to all of the consideration promised under the contract if it continues to perform as
promised.
Therefore, the criterion on whether an entity’s performance creates an asset with no alternative use to the entity
and the entity has an enforceable right to payment for performance created to date is met.
The entity recognizes revenue over time by measuring the progress toward complete satisfaction of the
performance obligation — see Section 6.4 for discussion on measure of progress.
BDO INSIGHTS — EXAMPLE 6-11 AND CERTAIN CONSTRUCTION CONTRACTS
When constructing certain buildings, such as a multi-unit residential complex, an entity may have entered into
contracts with multiple customers for the construction of individual units within the complex. The entity accounts
for each contract with a customer separately. However, depending on the nature of the construction, the entity’s
performance in undertaking the initial construction works (that is, the foundation and basic structure) and the
construction of common areas may need to be reflected when measuring its progress toward complete satisfaction
of its performance obligations in each contract. See Section 6.4 for discussion on measure of progress.
EXAMPLE 6-12 (ADAPTED FROM ASC 606-10-55-173 THROUGH 55-182): ASSESSING WHETHER A PERFORMANCE
OBLIGATION IS SATISFIED AT A POINT IN TIME OR OVER TIME - ENTITY HAS AN ENFORCEABLE RIGHT TO PAYMENT
FOR PERFORMANCE COMPLETED TO DATE
Assume the same facts in Example 6-11 except that in the event of a default by the customer, the entity can
exercise either of the following rights:
Require the customer to perform as required under the contract
Cancel the contract in exchange for the asset under construction and an entitlement to a penalty of a proportion
of the contract price
Regardless of the fact that the entity could cancel the contract (in which case the customer would be obligated to
the entity to transfer control of the partially completed unit to the entity and pay the specified penalty), the entity
has a right to payment for performance completed to date because the entity also could choose to enforce its rights
to full payment under the contract. The fact that the entity may choose to cancel the contract if the customer
defaults on its obligations does not affect the assessment of whether the entity has a right to payment for
performance completed to date, provided that the entity’s rights to require the customer to continue to perform as
required under the contract (by paying the promised consideration) are enforceable.
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CONCLUSION ON WHETHER AN ASSET HAS AN ALTERNATIVE USE MAY CHANGE IN SUBSEQUENT
CONTRACTS
In certain scenarios, an entity’s conclusion that an asset has no alternative use to the entity may be reassessed for
subsequent contracts with customers and could result in a different conclusion. Entities must monitor changes in
product and market, such as increases in customer base and the emergence of an expanded resale market, to
determine whether a reassessment of the conclusion that the asset has no alternative use is warranted for
subsequent contracts. See Example 6-13, which illustrates one such fact pattern.
However, the conclusion about whether an asset has an alternative use is not reassessed after contract inception
for a specific contract unless that contract is modified and the modified contract is not accounted for as a separate
contract. See Section 7.3 for a discussion on contract modification.
EXAMPLE 6-13: SUBSEQUENT CHANGE TO ASSESSMENT OF WHETHER ASSET HAS AN ALTERNATIVE USE TO THE
ENTITY
A manufacturing entity creates certain original parts for sale to an Original Equipment Manufacturer (OEM) who is
developing certain new products. Initially, the parts do not have an alternative use to the manufacturing entity
because they can only be sold to the OEM. Assume that the entity has a present right to payment for any production
completed to date. Therefore, the performance obligation in the contract is satisfied over time.
After a certain period of time, an aftermarket emerges such that the parts can now also be sold to other customers
because additional parts are manufactured under subsequent contracts entered with either the OEM or other
customers in the aftermarket. The existence of several customers for the parts suggests that as more parts are
manufactured under a new contract with a customer, those parts could typically be sold to other customers, with
subsequent production of additional units being used to satisfy the original contract. This indicates that once an
aftermarket emerges, the manufacturing entity may have an alternative use for parts being manufactured under
any particular contract with a customer. Therefore, the conditions for recognizing revenue over time may not be
met for contracts entered after the aftermarket develops.
6.4 MEASURING PROGRESS TOWARD COMPLETE SATISFACTION OF A PERFORMANCE
OBLIGATION
For each performance obligation satisfied over time, an entity recognizes revenue over time by measuring the progress
toward complete satisfaction of that performance obligation.
6.4.1 The Objective of Measuring Progress
FASB REFERENCES
ASC 606-10-25-31
The objective in measuring progress toward complete satisfaction of a performance obligation is to depict an entity’s
performance in transferring control of promised goods or services to a customer (that is, the satisfaction of an entity’s
performance obligation).
REVENUE RECOGNITION UNDER ASC 606 156
6.4.2 Methods for Measuring Progress
FASB REFERENCES
ASC 606-10-25-32 through 25-35
Appropriate methods of measuring progress include output methods and input methods. An entity must consider the
nature of the good or service that it promised to transfer to the customer to determine the appropriate method for
measuring progress for a specific performance obligation.
An entity must apply:
A single method of measuring progress for each performance obligation satisfied over time
That method consistently to similar performance obligations and in similar circumstances
BDO INSIGHTS — SELECTION OF MEASURE OF PROGRESS
Determining an appropriate measure of progress may require significant judgment, based on the facts and
circumstances. While ASC 606 does not require an entity to select a particular measure of progress for a particular
type of performance obligation, an entity does not have a free choice. Instead, the measure selected must
reasonably reflect the transfer of control of the promised goods or services to the customer. Therefore, an entity
must carefully consider whether the selected measure of progress meets that objective.
When applying a method for measuring progress, an entity must:
Exclude from the measure of progress any goods or services for which the entity does not transfer control to a
customer
Include in the measure of progress any goods or services for which the entity transfers control to a customer when
satisfying that performance obligation
An entity must remeasure its progress toward complete satisfaction of a performance obligation satisfied over time at
the end of each reporting period.
Additionally, an entity must update its measure of progress to reflect any changes in the outcome of the performance
obligation as circumstances change over time. Such changes to an entity’s measure of progress are accounted for as a
change in an accounting estimate in accordance with ASC 250.
TRG DISCUSSIONS — MEASURE OF PROGRESS
In July 2015, the TRG discussed how to measure progress when multiple goods or services are included in a single
performance obligation. Although a performance obligation may contain multiple goods or services, the standard
requires entities to apply a single method to measure progress toward the satisfaction of each performance
obligation. Entities cannot apply one method to one part of a performance obligation and a different method to
another part of that performance obligation.
TRG members stated that in some circumstances it may be difficult to identify a single measure of progress that
reflects the entity’s performance appropriately, which might indicate (albeit not definitively) that the entity has
not correctly identified the separate performance obligations. That is, there might be more than one performance
obligation.
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6.4.2.1 Output Methods
FASB REFERENCES
ASC 606-10-55-17 through 55-19
The application of an output method results in revenue recognition based on direct measurements of the value to the
customer of the goods or services transferred to date relative to the remaining goods or services promised under the
contract. Output methods include methods such as:
Surveys of performance completed to date
Appraisals of results achieved
Milestones reached
Time elapsed
Units produced or units delivered
In evaluating whether to apply an output method to measure its progress, an entity must consider whether the output
selected would faithfully depict the entity’s performance toward complete satisfaction of the performance obligation.
An output method does not provide a faithful depiction of the entity’s performance if the output selected fails to
measure some of the goods or services for which control has transferred to the customer. For example, output methods
based on units produced or units delivered (which exclude consideration for any work in process in the measurement of
the output) would not faithfully depict an entity’s performance in satisfying a performance obligation if, at the end of
the reporting period, the entity’s performance has produced work in process that is controlled by the customer.
The disadvantages of output methods are that the outputs used to measure progress may not be directly observable
and the information required to apply them may not be available to an entity without undue cost. Therefore, an input
method may be necessary to measure progress towards complete satisfaction of a performance obligation — see
Section 6.4.2.2 for discussion on input methods.
EXAMPLE 6-14 (ADAPTED FROM ASC 606-10-55-184 THROUGH 55-186): MEASURING PROGRESS WHEN MAKING
GOODS OR SERVICES AVAILABLE
An entity, an owner and manager of gymnasiums, contracts with a customer for one year of access to any of its
gymnasiums. The customer has unlimited use of the gymnasiums and promises to pay $150 each month.
The entity determines that its promise to the customer is to provide a service of making the gymnasiums available
for the customer to use as and when the customer wishes. That is, the entity’s promise is a stand-ready obligation
because the extent to which the customer uses the gymnasiums does not affect the amount of the remaining goods
and services to which the customer is entitled.
The entity concludes that the customer simultaneously receives and consumes the benefits of the entity’s
performance as it performs by making the gymnasiums available. Therefore, the entity’s performance obligation is
satisfied over time.
In considering the appropriate measure of progress, the entity evaluates the nature of its performance obligation
and determines that the customer benefits from the entity’s service of making the gymnasiums available evenly
throughout the year. That is, the customer benefits from having the gymnasiums available to use, regardless of
whether the customer uses it or not. Therefore, the entity concludes that the best measure of progress toward
complete satisfaction of its performance obligation is a time-based measure and recognizes revenue on a straight-
line basis throughout the year at $150 per month.
REVENUE RECOGNITION UNDER ASC 606 158
6.4.2.1.1 As-Invoiced Practical Expedient
FASB REFERENCES
ASC 606-10-55-18
As a practical expedient, an entity may recognize revenue in the amount to which it has a right to invoice a customer if
the entity has a right to consideration from the customer in an amount that corresponds directly with the value to the
customer of the entity’s performance completed to date. This expedient could be available, for example, for a service
contract in which an entity bills a fixed amount for each hour of service provided.
TRG DISCUSSIONS — AS-INVOICED PRACTICAL EXPEDIENT — UPFRONT PAYMENTS
In July 2015, the TRG members agreed that an entity is not precluded from applying the as-invoiced practical
expedient in situations in which the price per unit changes during the duration of the contract. They noted that
application of the practical expedient in those situations involves an analysis of the facts and circumstances of the
arrangement to determine whether the amount invoiced for goods or services reasonably represents the value to
the customer of the entity’s performance completed to date. This assessment may but is not required to include an
assessment of market or standalone selling price.
The TRG considered the following two examples and agreed that the as-invoiced practical expedient applies to
both:
Example A: Sale of Electricity
An energy entity, Power Seller, and its customer enter a contract for the purchase and sale of electricity over a
contract duration of six years. The customer is obligated to purchase 10 megawatts (MW) of electricity per hour for
each hour during the contract term (that is, 87,600 MWh per annual period) at the following prices that
contemplate the forward market price of electricity at contract inception:
Years 1-2: $50/MWh
Years 3-4: $55/MWh
Years 5-6: $60/MWh
The transaction price, which represents the amount of consideration to which Power Seller expects to be entitled in
exchange for transferring electricity to the customer, is $28,908,000 (calculated as the annual contract prices per
MWh multiplied by annual contract quantities).
Power Seller concludes that the promise to sell electricity represents one performance obligation that will be
satisfied over time.
Power Seller concludes that the as-invoiced practical expedient applies because the amount that will be billed to
the customer corresponds directly with the value to the customer of Power Seller’s performance completed to date.
The amount that will be billed is based on both (a) the units of power transferred to the customer and (b) a rate per
unit of power that is priced by reference to one or more market indicators (for example, the observable forward
commodity price curve).
While the rate per unit of power is not the same for the duration of the contract, the rates per unit reflect the
value to the customer because the rates are based on one or more market indicators. When assessing the
applicability of the expedient, a fixed price is not always required for the duration of the contract. However, a
price increase or decrease must be based on the value of those later units to the customer. Determining whether
the price change is consistent with the value to the customer often requires the use of judgment.
REVENUE RECOGNITION UNDER ASC 606 159
Example B: IT Outsourcing Arrangement
IT Seller and its customer enter an IT outsourcing arrangement in which IT Seller provides continuous delivery of
outsourced activities over the contract term of ten years. IT Seller’s activities include, for example, providing
server capacity, managing the customer’s software portfolio and running an IT help desk. Each activity has a
contractual minimum volume.
IT Seller concludes that each of the activities described will be satisfied over time.
The following are the payment terms:
The price per unit differs for each type of activity.
IT Seller invoices the customer monthly.
The total monthly invoice is calculated based on different units consumed for the respective activities. For
example, the billings might be based on millions of instructions per second of computing power, number of
software applications used, or number of employees supported.
The agreed upon pricing at contract inception reflects market pricing.
The pricing decreases to reflect the associated costs decreasing over the term of the contract as the level of
effort to complete the tasks decreases. While initially the tasks are performed by more expensive personnel for
activities that require more effort, the level of effort for the activities decreases later in the contract term, and
the tasks are performed by less expensive personnel.
The contract includes a price benchmarking clause whereby the customer engages a third-party benchmarking
firm to compare the contract pricing to current market rates at certain points in the contract term. There is an
automatic prospective price adjustment if the benchmark is significantly below IT Seller’s price.
Although each activity has a contractual minimum, the fixed minimum amount is not considered substantive
because the customer is expected to exceed that minimum (in part, based on historical experience). Therefore,
the customer pays the IT Seller the relevant price per unit and the amount billed to the customer reflects the
rates and amounts (price and quantities) for the activities provided.
The TRG agreed that the as-invoiced practical expedient is applicable because the amount billed to the customer
corresponds directly with the value to the customer of IT Seller’s performance to date. Similar to Example A,
although the rates change for the respective activities over the duration of the arrangement, those rates reflect the
value to the customer, which is corroborated by both of the following:
The benchmarking (market) adjustment
Declining costs (and level of effort) of providing the tasks that correspond with the declining pricing of the
activities
Even though there are multiple activities in this example, the conditions to apply the as-invoiced practical
expedient are met because the amounts invoiced correspond with the value to the customer of each incremental
activity that the IT Seller provides to the customer (that is, the IT Seller’s performance completed to date).
Additionally, the FASB staff stated that while not included in the examples above, if a contract includes a volume
discount that is not substantive, then the value to the customer could directly correspond to the amount billed.
REVENUE RECOGNITION UNDER ASC 606 160
TRG DISCUSSIONS — AS-INVOICED PRACTICAL EXPEDIENT — UPFRONT PAYMENT AND BACK-END REBATE
In July 2015, the TRG agreed that the mere existence of an upfront payment or a back-end rebate in an
arrangement does not preclude an entity from applying the as-invoiced practical expedient. However, they stated
that an assessment of the significance of those upfront and back-end fees relative to the variable consideration in
the arrangement would likely be important in determining whether the expedient applies.
TRG DISCUSSIONS — EXISTENCE OF AN INVOICE OR PAYMENT SCHEDULE
In July 2015, the TRG agreed that the mere fact that an entity and its customer agree on an invoice or payment
schedule does not automatically mean the amount an entity has the right to invoice at a given point corresponds
directly with the value to the customer for the goods or services provided to date. For example, the customer might
request lower payments earlier in the duration of the contract and higher payments later in the duration to increase
its operating cash flow in the short term. As another example, the entity might request a significant payment early
in the duration of the contract to reduce credit risk or to have the customer demonstrate that it is committed to a
long-term service arrangement. The application of the as-invoiced practical expedient in those situations involves
an analysis of the facts and circumstances of the arrangement to determine whether the amount invoiced for goods
or services reasonably represents the value to the customer of the entity’s performance completed to date.
BDO INSIGHTS — AS-INVOICED PRACTICAL EXPEDIENT
To apply the as-invoiced practical expedient, an entity must conclude that the amount that will be invoiced to the
customer over the term of the contract corresponds directly with the value to the customer of the entity’s
performance completed to date throughout the contract term. Analyzing whether the invoiced amount corresponds
directly with the value to the customer might be complex and requires the application of professional judgment,
based on the facts and circumstances. Because of the complexity of this analysis, we have observed limited use of
the expedient in practice.
Additionally, we have observed in practice that when the performance obligation is a series of distinct services
satisfied over time (see Section 3.4 for related discussion) and the variable consideration allocation exception (see
Section 5.5 for related discussion) applies, the resulting revenue recognition may be similar to the outcomes under
the as-invoiced practical expedient. In those cases, applying the five-step revenue recognition model may be more
straightforward, and an entity may forego the expedient to avoid the burden of corroborating that it is applicable.
For example, consider a professional services entity that provides consulting services at a per-hour fee, which
increases annually in a multi-year contract (that is, the fee is variable). The fee is billed monthly. The contract
includes a single performance obligation, which is a series of distinct services satisfied over time. Each day of
service is distinct. The criteria for the variable consideration allocation exception are met because the terms of the
monthly fee relate specifically to the entity’s efforts to satisfy the distinct consulting services provided in a month,
and the resulting allocation is consistent with the allocation objective. Therefore, the entity recognizes the monthly
invoiced amount in revenue in the month to which the invoice relates. This approach to recognizing revenue is more
straightforward than determining whether the as-invoiced practical expedient applies, which would require an
analysis of whether the increases in fees correspond directly with the value to the customer of the entity’s
performance completed to date throughout the contract term.
REVENUE RECOGNITION UNDER ASC 606 161
In many cases, the measurement of revenue recognized for performance obligations satisfied over time may not be
the same as amounts invoiced to a customer. In those circumstances, an entity recognizes either a contract asset or
a contract liability for the difference between cumulative revenue recognized for a contract and cumulative
amounts invoiced to the customer.
6.4.2.2 Input Methods
FASB REFERENCES
ASC 606-10-55-20 and 55-21
The application of an input method results in revenue recognition based on an entity’s efforts or inputs to the
satisfaction of a performance obligation relative to the total expected inputs to the satisfaction of that performance
obligation. If the entity’s efforts or inputs are expended evenly throughout the performance period, it may be
appropriate for the entity to recognize revenue on a straight-line basis. Examples of input methods include:
Resources used
Labor hours expended
Costs incurred
Time elapsed
Machine hours used
A shortcoming of input methods is that there may not be a direct relationship between an entity’s inputs and the
transfer of control of goods or services to a customer. Therefore, to comply with the objective of measuring progress,
an entity must exclude from an input method the effects of any inputs that do not depict the entity’s performance in
transferring control of goods or services to the customer.
Following are examples of certain adjustments to the measure of progress that may be required when using a cost-
based input method:
Significant inefficiencies — If a cost incurred does not contribute to an entity’s progress in satisfying the
performance obligation, its effect must be excluded from the cost-based input method. For example, an entity
would not recognize revenue based on costs incurred that are attributable to significant inefficiencies in its
performance that were not reflected in the price of the contract (such as, the costs of unexpected amounts of
wasted materials, labor or other resources that were incurred to satisfy the performance obligation).
Uninstalled materials — If a cost incurred is not proportionate to the entity’s progress in satisfying the performance
obligation, the best depiction of the entity’s performance may be to adjust the input method to recognize revenue
only to the extent of that cost incurred. For example, a faithful depiction of an entity’s performance might be to
recognize revenue at an amount equal to the cost of a good used to satisfy a performance obligation if the entity
expects at contract inception that all of the following conditions would be met:
• The good is not distinct
• The customer is expected to obtain control of the good significantly before receiving services related to the good
• The cost of the transferred good is significant relative to the total expected costs to completely satisfy the
performance obligation
• The entity procures the good from a third party and is not significantly involved in designing and manufacturing
the good (but the entity is acting as a principal — see Section 7.2 for discussion on principal versus agent
considerations)
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6.4.2.2.1 Learning Curve
When determining the appropriate costs to include in the measure of progress and whether some of costs incurred are
attributable to significant inefficiencies, an entity must consider the effects of any learning curves. A learning curve is
the effect of efficiencies realized over time when an entity’s costs of performing a task decline in relation to the
number of times the entity performs that task. A learning curve can exist independently of a contract with a customer.
For example, a typical contract manufacturer may become more efficient in its production process over time as it
manufactures a product multiple times.
BC314 of ASU 2014-09 states that when an entity’s performance obligation is satisfied over time, applying a measure of
progress based on costs incurred would result in a higher recognition of revenue and expense for the early units
produced compared to the later units if the entity incurs higher costs to produce the early units and relatively lower
costs to produce the later units as production efficiencies are gained. In that scenario, a higher recognition of revenue
and expense for the early units produced is appropriate because of the greater value of the entity’s performance in the
early part of the contract. This is because if an entity were to sell only one unit, it would charge a customer a higher
price for that unit than the average unit price the customer pays when the customer purchases more than one unit.
EXAMPLE 6-15 (ADAPTED FROM ASC 606-10-55-187 THROUGH 55-192): UNINSTALLED MATERIALS
An entity enters a contract with a customer in October 20X2 to refurbish a multi-story building and install new
elevators for total consideration of $500,000 (the transaction price). Assume that the promised refurbishment service,
including the installation of elevators, is a single performance obligation. The entity determines that the performance
obligation is satisfied over time because the customer owns the building and controls the output of the refurbishment
as the entity performs.
Total expected costs are $400,000, including $150,000 for the elevators—expected costs are summarized below.
Expected Costs:
Elevators $ 150,000 37.5% of total expected costs
Other costs 250,000 62.5% of total expected costs
Total Expected Costs $ 400,000
The elevators are paid for and delivered at the site in November 20X2. The entity determines that it acts as a principal
because it obtains control of the elevators before they are transferred to the customer. See Section 7.2 for discussion
on principal versus agent considerations.
In considering the appropriate measure of progress, the entity evaluates the nature of its performance obligation
and determines that an input method based on costs is appropriate to measure its progress toward complete
satisfaction of the performance obligation. The entity then assesses whether the costs incurred to procure the
elevators are proportionate to the entity’s progress in satisfying its performance obligation. The entity observes the
following:
Although the elevators will not be installed until June 20X3, the customer obtains control of the elevators when
it is delivered to the site in November 20X2.
The costs to procure the elevators ($150,000) are significant relative to the total expected costs to completely
satisfy the performance obligation ($400,000).
The entity is not involved in designing or manufacturing the elevators.
As of December 31, 20X2, the entity has incurred other costs equaling $50,000 out of the total expected other
costs (excluding elevators) of $250,000.
The entity observes that the control of the elevators has passed to the customer in November 20X2 and therefore,
recognition of $150,000 (the costs for elevators) as an asset would be inappropriate and $150,000 must be
expensed. However, the entity also determines that it would be inappropriate to recognize 37.5% of total contract
revenue related to the costs for elevators and related profit because it has made limited progress in satisfying its
performance obligation to refurbish the building.
REVENUE RECOGNITION UNDER ASC 606 163
Based on the above analysis, the entity concludes that including the costs to procure the elevators ($150,000) in the
measure of progress would overstate the extent of the entity’s performance at December 31, 20X2. Therefore, the
entity:
Adjusts its measure of progress to exclude the costs to procure the elevators from the measure of costs incurred
and from the transaction price
Recognizes revenue for the transfer of the elevators in an amount equal to the costs to procure the elevators
(that is, at a zero margin)
As of December 31, 20X2, the entity observes that performance is 20% complete, calculated as $50,000 (other costs
incurred) divided by $250,000 (total expected other costs). Therefore, at December 31, 20X2, the entity recognizes
the following:
Revenue $ 220,000 Calculated as (20% of $350,000) plus $150,000, the
costs for elevators. $350,000 is calculated as
$500,000 less $150,000, the costs for elevators.
Cost of Goods Sold 200,000 Calculated as $50,000 (other costs incurred) plus
$150,000 (the costs incurred for elevators).
Profit $ 20,000
BDO INSIGHTS — COST-BASED INPUT METHODS
Cost-based input methods are commonly used as a measure of progress for revenue recognition in multiple
industries. While ASC 606 allows the use of a cost-based input method to measure progress to recognize revenue, it
provides very limited guidance on how to calculate the costs incurred and total expected costs (that is, the
numerator and denominator), which provide the basis (or percentage) for recognizing a portion of the transaction
price as revenue. Entities must carefully consider other U.S. GAAP that may be applicable to appropriately calculate
the costs included in the numerator and the denominator. Significant inaccuracies in calculating costs may result in
inappropriate revenue recognition. For example, not accruing costs incurred until invoices are paid may result in
under-recognition of costs incurred and therefore an understatement of revenue.
BDO INSIGHTS — OVER TIME REVENUE RECOGNITION AND WORK IN PROCESS
For performance obligations that are satisfied over time, an entity generally does not recognize any work in process
under ASC 330 (or an asset under other U.S. GAAP), because the fundamental principle underlying over time
revenue recognition is that control of the good or service is transferred to the customer continuously as the entity
fulfills its contractual obligations. Any inventory or raw material costs that are specific to a performance obligation
satisfied over time are expensed as those costs are assigned to that performance obligation and placed into
production. As a result, if output methods are used to measure performance to date, entities may often find that
profit margins vary over the contractual period. In some cases, losses may be experienced in some periods,
particularly in the early stages of the contract, even though the contract is anticipated to be profitable overall
because the measurement of cumulative (or periodic) outputs driving the amount of revenue recognized may not be
commensurate with the cumulative (or periodic) costs incurred.
REVENUE RECOGNITION UNDER ASC 606 164
BDO INSIGHTS — MEASURE OF PROGRESS — CUSTOMIZED PRODUCT THAT IS GENERIC UP TO A POINT IN THE
CONSTRUCTION OR MANUFACTURING PROCESS
An entity may construct or manufacture a customized product that remains generic up to the point in the
construction or manufacturing process when the customization begins but has no alternative use to the entity in its
completed form. See Example 6-6 for a related discussion. If the entity has an enforceable right to payment for
performance completed to date, it recognizes revenue over the construction or manufacturing process.
However, before the customization, the entity’s performance does not transfer an asset to the customer but rather
creates an asset (inventory) for the entity, because the entity can redirect the generic asset to another customer or
for another purpose. Only when the customization begins does the entity’s performance transfer the work in
process (asset) to the customer as the entity performs. Therefore, the entity begins to recognize revenue over time
only when the customization begins.
If an entity uses a costs-based measure of progress, the costs incurred before customization are included in the
measure of progress to determine the revenue to be recognized, and any related asset recognized for the work in
process (for example, inventory) is recognized in expense at that point.
BDO INSIGHTS — ACCOUNTING FOR PARTIAL SATISFACTION OF A PERFORMANCE OBLIGATION BEFORE THE
CONTRACT EXISTENCE CRITERIA ARE MET
Sometimes an entity may start providing goods or services which comprise a performance obligation satisfied over
time before the contract existence criteria in Step 1 are met — see Section 2.2 for discussion on contract existence
criteria. Regardless of the entity’s ongoing performance to satisfy the performance obligation over time, it may not
recognize revenue before the contract existence criteria are met. Rather, the entity begins to recognize revenue
when the contract existence criteria are met. This fact pattern may arise, for example, when an entity starts to
manufacture a highly customized good or provide a service in advance of obtaining an expected contract from a
customer. When the entity subsequently determines that the contract existence criteria are met, the question
arises as to whether revenue is recognized prospectively from contract inception or if there is a cumulative catch-
up adjustment for the work done to date.
Consistent with views expressed at the TRG meeting in March 2015, when a similar issue was discussed, we believe
revenue is recognized on a cumulative catch-up basis because ASC 606 requires an entity to recognize revenue when
(or as) an entity satisfies performance obligations by transferring promised goods or services to a customer. This
occurs when (or as) the customer obtains control of the good or service. If at the point at which the contract
existence criteria are met the entity has satisfied part or all of certain performance obligations by transferring fully
or partially completed goods or services to its customer, the entity must recognize in revenue the related amount of
consideration to which it expects to be entitled.
Recognizing revenue on a prospective basis only from the point in time at which the contract existence criteria are
met is inconsistent with the notion of control underlying the five-step revenue recognition model because the
control of certain goods or services is transferred to the customer at contract inception.
Note that the costs incurred for those arrangements may have to be recognized before the revenue recognition
begins. See Section 7.7 for a discussion of accounting for contract costs.
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TRG DISCUSSIONS — STAND–READY OBLIGATIONS
In January 2015, the TRG discussed the nature of an entity’s promise in stand-ready obligations and how an entity
should measure progress towards completion of a stand-ready obligation that is satisfied over time.
As discussed in Chapter 3, a stand-ready performance obligation is one in which the entity provides a service of
standing ready to provide goods or services. The customer consumes and receives benefit from a stand-ready
obligation from the assurance that a resource is available to it when and if needed or called upon.
Following are the examples of different types of stand-ready obligations that were considered by the TRG:
Obligations in which the delivery of the good(s), service(s) or IP underlying the obligation is within the control of
the entity, but for which the entity must still further develop its good(s), service(s) or IP. For example, a
software entity might promise to transfer unspecified software upgrades at the entity’s discretion, or a
pharmaceutical entity might promise to provide when-and-if-available updates to previously licensed IP based on
advances in R&D.
Obligations in which the delivery of the underlying good(s) or service(s) is outside the control of the entity and
customer. For example, an entity promises to remove snow from an airport’s runways in exchange for a fixed fee
each year.
Obligations in which the delivery of the underlying good(s) or service(s) is within the control of the customer. For
example, an entity might agree to provide periodic maintenance on a customer’s equipment after a pre-
established amount of usage by the customer.
Obligations to make a good or service available to the customer continuously, such as a gym or health club
membership.
TRG members agreed that an entity must exercise judgment in determining the appropriate method to measure
progress towards satisfaction of a stand-ready obligation over time, and the substance of the stand-ready obligation
must be considered to align the measurement of progress towards complete satisfaction of the performance
obligation with the nature of the entity’s promise. The TRG also observed that while a straight-line measure of
progress might not always be conceptually pure, it might be the most reasonable estimate an entity can make for a
stand-ready obligation.
BDO INSIGHTS — MEASURE OF PROGRESS FOR A STAND-READY PERFORMANCE OBLIGATION
Consistent with the TRG discussion, we believe an entity must not default to straight-line measure of progress for a
stand-ready performance obligation. Rather, an entity must consider the nature of its obligation and the relevant
facts and circumstances to determine the appropriate method for measuring its progress in satisfying its stand-ready
obligation. For example, consider an entity that enters an annual contract with a customer to provide snow removal
services in New York. While the nature of the entity’s promise is to stand-ready to remove snow as it falls, a
straight-line measure of progress is not appropriate for revenue recognition because it would not reflect the pattern
of benefit of the snow removal services to the customer or the entity’s effort in providing those services. Rather,
the entire consideration allocated to the entity’s obligation for snow removal must be recognized during the winter
months when snow is expected to fall in New York. Note that this pattern could be different, for example, in Alaska
which receives more snowfall than New York or Texas which receives less snowfall than New York.
REVENUE RECOGNITION UNDER ASC 606 166
6.4.3 Reasonable Measures of Progress
FASB REFERENCES
ASC 606-10-25-36 and 25-37
An entity recognizes revenue for a performance obligation satisfied over time only if the entity can reasonably measure
its progress toward complete satisfaction of the performance obligation. An entity would not be able to reasonably
measure its progress toward complete satisfaction of a performance obligation if it lacks reliable information that
would be required to apply an appropriate method of measuring progress.
In some circumstances (for example, in the initial stages of a contract), an entity may not be able to reasonably
measure the outcome of a performance obligation but may expect to recover the costs incurred in satisfying the
performance obligation. In those circumstances, the entity recognizes revenue only to the extent of the costs incurred
until such time that it can reasonably measure the outcome of the performance obligation.
BC179 of ASU 2014-09 states that unless the entity can recognize an asset from the costs to fulfill a contract, any costs
related to the promise would not represent an asset of the entity and therefore is recognized as expenses as they are
incurred. See Section 7.7 for discussion on contract costs.
BC180 of ASU 2014-09 further states that in cases in which an entity cannot reasonably measure its progress toward
complete satisfaction of a performance obligation, but nevertheless expects eventually to recover the costs incurred in
satisfying the performance obligation, the entity must recognize at least some amount of revenue to reflect the fact
that it is making progress in satisfying the performance obligation. Therefore, the FASB concluded that in those cases,
an entity must recognize revenue for the satisfaction of the performance obligation only to the extent of the costs
incurred. However, the FASB also concluded that an entity must stop using that method when it can reasonably
measure its progress toward complete satisfaction of the performance obligation and select an appropriate method to
measure progress.
BDO INSIGHTS — INABILITY TO REASONABLY MEASURE PROGRESS IS EXPECTED TO BE RARE
We believe it would be rare that an entity could not reasonably measure its progress toward complete satisfaction
of a performance obligation. The guidance in ASC 606 is consistent with the prior revenue recognition guidance in
ASC 605-35, Revenue ― Construction-Type and Production-Type Contracts, superseded by ASC 606. While the
language in ASC 605-35-25-59 was not carried forward into ASC 606, we believe the concepts articulated there are
still relevant. Specifically, that paragraph stated that there is a presumption that entities whose business model
involves the production of goods or services under contractual arrangements do have the ability to make estimates
that are sufficiently dependable to justify the use of the percentage-of-completion model and persuasive evidence
to the contrary is necessary to overcome that presumption. We believe a similar presumption exists under ASC 606
that entities who promise goods or services that meet the criteria to be accounted for over time can make reliable
estimates of progress and persuasive evidence is needed to overcome that presumption.
REVENUE RECOGNITION UNDER ASC 606 167
6.5 PERFORMANCE OBLIGATIONS SATISFIED AT A POINT IN TIME
FASB REFERENCES
ASC 606-10-25-30
An entity satisfies a performance obligation at a point in time if the performance obligation does not meet the criteria
for being satisfied over time. For a performance obligation satisfied at a point in time, the performance obligation is
satisfied at the point in time at which control of the goods or services transfers to the customer. To determine the
point in time at which a customer obtains control of a promised asset and the entity satisfies a performance obligation,
the entity must consider the guidance on control — see Section 6.2 for discussion on control.
Additionally, an entity must consider indicators of the transfer of control, which include, but are not limited to, the
following:
The entity has a present right to payment for the asset — A customer’s present obligation to pay for an asset may
indicate that the customer has obtained the ability to direct the use of, and obtain substantially all of the remaining
benefits from, the asset.
The customer has legal title to the asset — Legal title may indicate whether the entity or a customer has the
ability to direct the use of, and obtain substantially all of the remaining benefits from, an asset or to restrict the
access of other entities to those benefits. Therefore, the transfer of legal title of an asset may indicate that the
customer has obtained control of the asset. However, if an entity retains legal title solely as protection against the
customer’s failure to pay, those protective rights of the entity would not preclude the customer from obtaining
control of an asset.
The entity has transferred physical possession of the asset — The customer’s physical possession of an asset may
indicate that the customer has the ability to direct the use of, and obtain substantially all of the remaining benefits
from, the asset or to restrict the access of other entities to those benefits. However, physical possession may not
necessarily coincide with control of an asset. For example, in some repurchase agreements or consignment
arrangements, a customer or consignee may have physical possession of an asset that the entity controls.
Conversely, in some bill-and-hold arrangements, the entity may have physical possession of an asset that the
customer controls. Accounting for repurchase agreements, consignment arrangements and bill-and-hold
arrangements are discussed in Sections 6.6, 6.7, and 6.8, respectively.
The customer has the significant risks and rewards of ownership of the asset — The transfer of the significant
risks and rewards of ownership of an asset to the customer may indicate that the customer has obtained the ability
to direct the use of, and obtain substantially all of the remaining benefits from, the asset. However, when
evaluating the risks and rewards of ownership of a promised asset, an entity must exclude any risks that give rise to
a separate performance obligation in addition to the performance obligation to transfer the asset. For example, an
entity may transfer control of a car to a customer without yet satisfying an additional performance obligation to
provide maintenance services related to the transferred car. BC154 of ASU 2014-09 states the FASB’s belief that
risks and rewards can be a helpful factor to consider when determining the transfer of control and can often be a
consequence of controlling an asset. However, whether the customer has the significant risks and rewards of
ownership is only one indicator of control and does not change the principle of determining the transfer of goods or
services based on the transfer of control.
The customer has accepted the asset — The customer’s acceptance of an asset may indicate that it has obtained
the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset. An entity must
evaluate the effect of a contractual customer acceptance clause on when control of an asset is transferred — see
Section 6.9 for related discussion.
REVENUE RECOGNITION UNDER ASC 606 168
INDICATORS OF CONTROL — NOT A CHECKLIST
BC155 of ASU 2014-09 states that the indicators of control are not a list of conditions that must be met before an
entity can conclude that control of a good or service has transferred to a customer. Rather, the indicators are a list
of factors that are often present if a customer has control of an asset. That list is provided to assist entities in
applying the principle of control. Accordingly, all indicators need not be present for an entity to conclude that it
has transferred control of a good or service.
EXAMPLE 6-16: RISK AND REWARD VERSUS TRANSFER OF CONTROL
A property development entity enters contracts with customers to sell separate units of residential or commercial
properties in multi-unit developments (for example, apartment blocks or office buildings).
On January 1, 20X1, a customer enters a binding contract for the unit and pays a 10% deposit of the contractually
agreed purchase price.
The unit is incomplete at January 1, 20X1, (for example, because the unit has been sold off plan, or some but
not all of construction activities have been completed); the entity must complete the construction of the unit on
June 1, 20X2.
From the point in time when construction of the unit is complete, the customer assumes certain ownership risks,
including risks from damage to the unit caused by an event (for example, severe weather) or by unrelated third
parties.
On June 15, 20X2, the customer must pay the balance of purchase price and take ownership, with legal title
passing from the entity to its customer.
If the customer does not fulfill its contractual obligation to pay the balance of the consideration on June 15,
20X2:
• The entity has the right to retain the 10% deposit that was paid on January 1, 20X1.
• The customer is contractually required to compensate the entity for certain loss of profit — the customer is
required the pay the shortfall to the entity if the entity is unable to obtain a price of at least 90% of the
contractually agreed price from sale to another customer.
• The local courts in the entity’s jurisdiction will likely enforce the compensation clauses stated above, based
on the substantial legal precedence.
The customer is exposed to subsequent changes in the market value of the unit from January 1, 20X1, because
the customer has entered a binding sales contract.
The customer is not allowed to occupy or sublet the unit and may have either limited or no rights to access the
unit until June 15, 20X2. Additionally, the customer does not have the right to make any changes to the unit or
to pledge it as security in transactions such as a lending arrangement until June 15, 20X2.
Assume the unit is the sole performance obligation in the contract.
The entity first considers whether the performance obligation is satisfied over time and hence revenue must be
recognized over time. If none of the over time revenue recognition criteria are met, then revenue must be
recognized at a point in time.
In determining whether the performance obligation is satisfied over time, the entity considers it has a right to only
the upfront deposit until the unit’s construction is complete. Accordingly, the entity determines that it does not
have an enforceable right to payment for work completed to date at all times for the contract’s duration.
Therefore, the entity’s performance obligation is not satisfied over time in accordance with the criterion on
whether an entity’s performance creates an asset with no alternative use to the entity and the entity has an
REVENUE RECOGNITION UNDER ASC 606 169
enforceable right to payment for performance created to date. Since none of the other over time revenue
recognition criteria are met, the entity accounts for the sale of the unit as a performance obligation satisfied at a
point in time.
In determining the point in time at which the performance obligation is satisfied, the entity considers that although
the customer assumes certain risks at January 1, 20X1, and June 1, 20X2, the restrictions over the customer’s
ability to derive benefits from the unit until June 15, 20X2, indicate that control of the unit does not transfer to the
customer until June 15, 20X2.
Therefore, the entity recognizes revenue from the sale of unit on June 15, 20X2.
BDO INSIGHTS — SIGNIFICANCE OF LOCAL LAWS IN DETERMINING THE PATTERN OF REVENUE RECOGNITION
In determining when to recognize revenue, it is important to understand the legal environment as well as the
contractual terms and conditions because local laws and regulations may affect the assessment of whether control
transfers to the customer at a point in time or over time and if at a point in time, the specific date.
Additionally, application of the over-time revenue recognition criterion in Section 6.3.3 (whether an entity’s
performance creates an asset with no alternative use to the entity and the entity has an enforceable right to
payment for performance created to date) particularly affects the pattern and timing of revenue recognition in
multiple industries, for example, contract manufacturing. Entities must carefully consider their specific contracts
with customers and legal environments to determine the appropriate patterns of revenue recognition under
ASC 606.
6.6 REPURCHASE AGREEMENTS
FASB REFERENCES
ASC 606-10-55-66 and 55-67
A repurchase agreement is a contract in which an entity sells an asset to a customer and also promises to or has the
right to, either in the same contract or in another contract, repurchase the asset. The repurchased asset may be any of
the following:
The asset that was originally sold to the customer
An asset that is substantially the same as the asset originally sold to the customer
Another asset of which the asset that was originally sold is a component
Repurchase agreements generally come in three forms:
A forward — An entity’s obligation to repurchase the asset.
A call option — An entity’s right to repurchase the asset.
A put option — An entity’s obligation to repurchase the asset at the customer’s request.
REVENUE RECOGNITION UNDER ASC 606 170
6.6.1 A Forward or a Call Option
FASB REFERENCES
ASC 606-10-55-68 through 55-71
The following diagram provides an overview of the accounting considerations for repurchase rights in a forward or call
option:
If an entity has an obligation or a right to repurchase the asset (that is, a forward or a call option), then a customer
does not obtain control of the asset because the customer is limited in its ability to direct the use of, and obtain
substantially all of the remaining benefits from, the asset even though the customer may have physical possession of
the asset. Therefore, an entity does not recognize revenue for that contract but instead, depending on the repurchase
price of the asset as compared to its original selling price, accounts for that contract as a lease or financing.
A financing arrangement — If the entity can or must repurchase the asset for an amount that is equal to or more
than the original selling price of the asset, then the entity must account for the arrangement as a financing
arrangement. An entity accounts for a financing arrangement as follows:
• Continue to recognize the asset
• Recognize a financial liability for any consideration received from the customer
• Recognize as interest (and, if applicable, as processing or holding costs (for example, insurance)) the difference,
if any, between the amount of consideration received from the customer and the amount of consideration to be
paid to the customer
Forwards and Call Options
If an entity has an obligation or a right to repurchase the asset, control of the asset does not transfer to
th
e customer. Accounting for the arrangement depends on the repurchase price.
Account for the
arrangement as a
lease.
Account for the
arrangement as a
financing.
Would the entity repurchase the asset for less than its
original selling price?
Is the contract part
of a sale-leaseback
transaction?
Yes
Yes
No
No
REVENUE RECOGNITION UNDER ASC 606 171
A lease — If the entity can or must repurchase the asset for an amount that is less than the original selling price of
the asset and the contract is not part of a sale-leaseback transaction, then the entity must account for the
arrangement as a lease in accordance with ASC 842.
10
If the contract is part of a sale-leaseback transaction, then
the entity must account for the arrangement as a financing arrangement and not as a sale-leaseback under
ASC 842 -40.
BC427 of ASU 2014-09 states that an entity does not consider the likelihood that a call option will be exercised because
the existence of the call option effectively limits the customer’s ability to control the asset. However, a
nonsubstantive call option is ignored in assessing whether and when the customer obtains control of a good.
An entity considers the time value of money when comparing the repurchase price with the selling price of the asset.
An entity must derecognize the liability and recognize revenue if the call option lapses unexercised.
BDO INSIGHTS — CONTINGENTLY EXERCISABLE REPURCHASE RIGHT HELD BY AN ENTITY
ASC 606 does not include guidance on contingently exercisable repurchase right held by an entity. An entity must
carefully evaluate the substance of a repurchase right and the surrounding facts and circumstances and determine
whether control of an asset underlying the contingent repurchase right has transferred to a customer. An entity may
consider factors such as:
The nature of the contingency
Whether the contingency is within the control of the entity or customer
The likelihood that the contingency will be met (but not the likelihood of exercise of the repurchase right)
The existence of a contingently exercisable repurchase right does not always preclude transfer of control to the
customer. For example, if the contingency is outside the control of an entity, the entity may conclude that control
has transferred to the customer and account for the transaction as a sale with a right of return.
EXAMPLE 6-17 (ADAPTED FROM ASC 606-10-55-401 THROUGH 55-407): REPURCHASE AGREEMENTS — CALL
OPTION: FINANCING
An entity enters a contract with a customer for the sale of an item of equipment on January 1, 20X1, for $10
million.
The contract includes a call option that provides the entity the right to repurchase the asset for $11 million on or
before December 31, 20X1.
The entity determines that control of the equipment does not transfer to the customer on January 1, 20X1, because
the entity has a right to repurchase the asset, which limits the customer in its ability to direct the use of, and
obtain substantially all of the remaining benefits from, the asset. Therefore, the entity accounts for the transaction
as a financing arrangement because the exercise price of the call option ($11 million) is more than the original
selling price ($10 million). The entity:
Does not derecognize the equipment
Recognizes the cash received as a financial liability
Recognizes interest expense for the difference between the exercise price ($11 million) and the cash received
($10 million), which increases the liability
If the option lapses unexercised on January 1, 20X2, the entity would derecognize the liability and recognize
revenue of $11 million.
10
See our Blueprint, Accounting for Leases Under ASC 842, for guidance on ASC 842.
REVENUE RECOGNITION UNDER ASC 606 172
6.6.2 A Put Option
FASB REFERENCES
ASC 606-10-55-72 through 55-78
The following diagram gives an overview of the accounting considerations for an entity’s repurchase obligation in a put
option:
If an entity has an obligation to repurchase the asset at
a customer’s request,
accounting for the arrangement is based on the comparison of the repurchase price
and the original selling price.
Is the contract
part of a sale-
leaseback
transaction?
Put Options
Account for
the
arrangement
as a lease.
Is the
repurchase
price less than
the original
selling price of
the asset?
Account for the
arrangement as a
sale with a right of
return if the
customer does not
have a significant
incentive to
exercise the put
option.
*If the repurchase price is expected to significantly exceed the market value of the
asset, this may indicate that the customer has a significant economic incentive to
exercise the put option.
Account for
the
arrangement
as a sale with
a right of
return.
Account for
the
arrangement
as a
financing.
Does the
customer have
a significant
incentive to
exercise the
put option?*
No
Yes
No
Yes
No
Yes
Yes
No
Is the repurchase
price more than the
expected market
value of the asset?
REVENUE RECOGNITION UNDER ASC 606 173
If an entity has an obligation to repurchase the asset at the customer’s request, the appropriate accounting treatment
is determined based on a comparison of the repurchase price and the original selling price.
6.6.2.1 Repurchase Price is Lower Than the Original Selling Price
If the customer can require an entity to repurchase the asset at a price that is lower than the original selling price of
the asset, then the entity considers at contract inception whether the customer has a significant economic incentive to
exercise that right. The exercise of that right by the customer results in the customer effectively paying the entity
consideration for the right to use that asset for a period of time. Therefore, if the customer has a significant economic
incentive to exercise that right and the contract is not part of a sale-leaseback transaction, then the entity must
account for the agreement as a lease in accordance with ASC 842.
11
If the contract is part of a sale-leaseback
transaction, then the entity must account for the arrangement as a financing arrangement and not as a sale-leaseback
under ASC 842-40.
However, if the customer does not have a significant economic incentive to exercise its right at a price lower than the
original selling price of the asset, then the entity accounts for the agreement as if it were the sale of a product with a
right of return (see Section 4.3.8 for discussion on sale with a right of return).
To determine whether a customer has a significant economic incentive to exercise its right, an entity must consider
various factors, including the relationship of the repurchase price to the expected market value of the asset at the
date of the repurchase and the amount of time until the right expires. For example, a repurchase price that is
expected to significantly exceed the market value of the asset at the date of repurchase may indicate that the
customer has a significant economic incentive to exercise the put option.
6.6.2.2 Repurchase Price is Equal to or Greater Than the Original Selling Price
If the repurchase price of the asset is equal to or greater than the original selling price, the accounting is based on a
comparison the repurchase price and expected market value of the asset as follows:
If the repurchase price of the asset is more than the expected market value of the asset, then the contract is in
effect a financing arrangement. An entity must recognize a financial liability equal to the amount of consideration
received, and the asset is not derecognized. Any difference between the consideration received from the customer
and the amount paid to the customer in the future when the put right is exercised is recognized as interest expense,
and as other holding costs such as insurance if applicable. If the put option lapses unexercised, entity derecognizes
the liability and recognizes revenue.
If the repurchase price of the asset is less than or equal to the expected market value of the asset, and the
customer does not have a significant economic incentive to exercise its right, then the entity must account for the
contract as if it were the sale of a product with a right of return (see Section 4.3.8 for discussion on sale with a
right of return).
An entity considers the time value of money when comparing the repurchase price with the selling price of the asset.
BDO INSIGHTS — REPURCHASE AGREEMENTS
The guidance on repurchase agreements in ASC 606 may have a significant impact in some industries. For example,
an entity may sell a car to a customer while providing the customer a right to require the entity to repurchase the
car for a specified price after a period of time. Careful consideration of the exercise price of a customer put option
is required to determine the nature of the arrangement as a sale or lease. Additionally, an entity must carefully
identify the various parties to the arrangements and their rights or obligations. For example, an entity must
consider:
Whether the entity itself or an unrelated third-party finance entity grants the put option to the customer
If an unrelated third-party finance entity grants the put option to the customer, whether there are any
associated contractual arrangements between the entity and that third-party finance entity
11
See our Blueprint, Accounting for Leases Under ASC 842, for guidance on ASC 842.
REVENUE RECOGNITION UNDER ASC 606 174
Reaching conclusions about accounting for repurchase agreements requires the application of professional
judgment, based on the facts and circumstances.
EXAMPLE 6-18 (ADAPTED FROM ASC 606-10-55-401 THROUGH 55-407): REPURCHASE AGREEMENTS — PUT
OPTION: LEASE
An entity enters a contract with a customer for the sale of an item of equipment on January 1, 20X1, for $10
million.
The contract includes a put option that obliges the entity to repurchase the equipment at the customer’s request
for $9 million on or before December 31, 20X1. The market value is expected to be $7.5 million on December 31,
20X1.
To determine the accounting for the transfer of the equipment, the entity assesses at contract inception whether
the customer has a significant economic incentive to exercise the put option. The entity observes that the
repurchase price ($9 million) significantly exceeds the expected market value ($7.5 million) of the asset at the date
of repurchase and, therefore, concludes that the customer has a significant economic incentive to exercise the put
option. The entity determines there are no other relevant factors to consider in assessing whether the customer has
a significant economic incentive to exercise the put option.
Therefore, the entity concludes that control of the equipment does not transfer to the customer because the
customer is limited in its ability to direct the use of, and obtain substantially all of the remaining benefits from, the
equipment. The entity accounts for the transaction as a lease under ASC 842.
12
12
See our Blueprint, Accounting for Leases Under ASC 842, for guidance on ASC 842.
REVENUE RECOGNITION UNDER ASC 606 175
EXAMPLE 6-19: REPURCHASE AGREEMENTS — CUSTOMER PUT OPTION
An entity, a manufacturer of industrial equipment, enters a contract with a customer to sell an item of equipment
to the customer for a sales price of $750. The cost of manufacturing the equipment is $500. The expected useful
life of the equipment is five years.
The contract provides the customer with a right to return the equipment to the entity after two years in exchange
for a predetermined amount of $450 (the repurchase price). At contract inception, the fair value of the equipment
after two years is expected to be in the range of $425 to $475 with a linear distribution of expected values (that is,
the mean of the various estimates is $450). The present value of the repayment obligation, discounted at the
entity’s incremental borrowing rate of 6%, is $400.
The entity observes the following at contract inception:
The repurchase price of $450 is less than the original sales price of $750.
The customer does not have a significant economic incentive to exercise the option to return the equipment
because the repurchase price is not significantly more than the expected market value of the equipment, and no
other factor would compel the customer to exercise the option.
Therefore, the entity accounts for the transaction as a sale with a right of return (see Section 4.3.8 for related
discussion).
6.7 CONSIGNMENT ARRANGEMENTS
FASB REFERENCES
ASC 606-10-55-79 and 55-80
When an entity delivers a product to another party (for example, a dealer, retailer, or distributor) for resale to
end customers, the entity must evaluate whether that other party has obtained control of the product at that point in
time. A product delivered to another party may be held in a consignment arrangement if that other party has not
obtained control of the product.
REVENUE CANNOT BE RECOGNIZED FOR CONSIGNMENT ARRANGEMENTS
An entity cannot recognize revenue upon delivery of a product to another party if the delivered product is held on
consignment.
Indicators that an arrangement is a consignment arrangement include, but are not limited to, the following:
The product is controlled by the entity until a specified event occurs (for example, the subsequent sale of the
product to a customer of the dealer, retailer, or distributor) or until a specified period expires.
The entity can require the return of the product or transfer the product to a third party (for example, another
dealer, retailer, or distributor).
The dealer, retailer, or distributor does not have an unconditional obligation to pay for the product (although it
might be required to pay a deposit).
REVENUE RECOGNITION UNDER ASC 606 176
BDO INSIGHTS — CONTRACTS WITH PRICE PROTECTION CLAUSES
Sometimes an entity may provide certain pricing protection to its customers who resell its products to end
customers. For example, an entity might provide a retrospective reduction in the purchase price if the entity lowers
its price in the future or if the entity agrees to sell similar products to another customer at a lower price. Clauses
such as “most favored nation” or “most favored customer” are common for providing such pricing protection to a
customer. Additionally, an entity may allow a customer (reseller) to return unsold items for a refund. While such
provisions limit the customer’s risks associated with purchasing the goods, they do not necessarily preclude the
customer from obtaining control of the items. Instead, these types of provisions typically result in the price per
item being variable. See Section 4.3 for discussion on accounting for variable consideration.
6.8 BILL-AND-HOLD ARRANGEMENTS
FASB REFERENCES
ASC 606-10-55-81 through 55-84
A bill-and-hold arrangement is a contract under which an entity bills a customer for a product, but the entity retains
physical possession of the product until it is transferred to the customer at a point in time in the future. For example,
a customer may request a bill-and-hold arrangement because the customer lacks available space for the product or
because of delays in the customer’s production schedules.
When considering an entity has satisfied its performance obligation to transfer a product under a bill-and-hold
arrangement, an entity must evaluate when the customer obtains control of that product. For some contracts, control
of a product is transferred to customer either when the product is delivered to the customer’s site or when the product
is shipped, depending on the terms of the contract (including delivery and shipping terms). However, for some
contracts, a customer may obtain control of a product even though that product remains in an entity’s physical
possession. In those cases:
The customer has the ability to direct the use of and obtain substantially all of the remaining benefits from the
product even though it has decided not to exercise its right to take physical possession of that product.
The entity does not control the product but rather provides custodial services to the customer over the customer’s
asset.
ADDITIONAL REVENUE RECOGNITION CRITERIA FOR BILL-AND-HOLD ARRANGEMENTS
In addition to applying the guidance on transfer of control (see Section 6.2 for related discussion), all of the
following criteria must be met for a customer to have obtained control of a product in a bill-and-hold arrangement:
The reason for the bill-and-hold arrangement must be substantive (for example, the customer requests the
arrangement).
The product must be identified separately as belonging to the customer.
The product currently must be ready for physical transfer to the customer.
The entity cannot have the ability to use the product or to direct it to another customer.
If an entity recognizes revenue for the sale of a product on a bill-and-hold basis, the entity must consider whether it
has any remaining performance obligations (for example, for custodial services) to which the entity needs to allocate a
REVENUE RECOGNITION UNDER ASC 606 177
portion of the transaction price. See Chapters 3 and 5 for discussion on identification of performance obligations and
allocation of transaction price to the performance obligations, respectively.
EXAMPLE 6-20 (ADAPTED FROM ASC 606-10-55-409 THROUGH 55-413): BILL-AND-HOLD ARRANGEMENT
An entity enters a contract with a customer on January 1, 20X1, for the sale of an item of equipment and spare
parts. The manufacturing lead time for the equipment and spare parts is two years. Assume that the promises to
transfer the equipment and spare parts are distinct and result in two performance obligations that each will be
satisfied at a point in time.
Upon completion of manufacturing, the entity demonstrates that the equipment and spare parts meet the
contractually agreed-upon specifications.
On December 31, 20X2, the customer pays for both the equipment and spare parts but only takes physical
possession of the equipment. Although the customer inspects and accepts the spare parts, the customer requests
that the spare parts be stored at the entity’s warehouse because of its proximity to the customer’s factory.
Following are additional details of the arrangement that indicate all of the criteria for transfer of control in the bill-
and-hold arrangement are met:
The customer has legal title to the spare parts.
The parts can be identified as belonging to the customer.
The entity stores the spare parts in a separate section of its warehouse.
The parts are ready for immediate shipment at the customer’s request.
The entity expects to hold the spare parts for two to four years, and the entity does not have the ability to use
the spare parts or direct them to another customer.
The entity identifies the promise to provide custodial services as a performance obligation because it is a service
provided to the customer that is distinct from the equipment and spare parts.
Therefore, the entity accounts for three performance obligations in the contract: the promises to provide the
equipment, the spare parts, and the custodial services. The transaction price is allocated to the three performance
obligations, and revenue is recognized when (or as) control transfers to the customer:
Equipment — The entity determines that control of the equipment transfers to the customer on December 31,
20X2, when the customer takes physical possession.
Spare parts — In determining the point in time at which control of the spare parts transfers to the customer, the
entity notes the following and recognizes revenue for the spare parts on December 31, 20X2, when control
transfers to the customer:
• The entity has received payment.
• The customer has legal title to the spare parts.
• The customer has inspected and accepted the spare parts.
• All criteria for transfer of control in the bill-and-hold arrangement are met, which is necessary for the entity
to recognize revenue in a bill-and-hold arrangement.
Custodial services — The entity determines that the performance obligation to provide custodial services is
satisfied over time as those services are provided.
See Sections 6.2, 6.3, and 6.5 for discussion on transfer of control and whether a performance obligation is satisfied
over time or at a point in time.
REVENUE RECOGNITION UNDER ASC 606 178
BDO INSIGHTS — BILL-AND-HOLD ARRANGEMENTS
Under ASC 606, some types of bill-and-hold arrangements may not qualify for revenue recognition until the delivery
of the product to the customer’s site or shipment (depending on the terms of the contract). Reaching a conclusion
on when revenue from a bill-and-hold arrangement is recognized requires the application of professional judgment,
based on the facts and circumstances.
Additionally, careful consideration of the terms of bill-and-hold arrangements is required to determine whether
there are additional performance obligations (for example, custodial services) to which some of the transaction
price for the sale of goods must be allocated. Promises that are immaterial to the contract are not required to be
accounted for as distinct performance obligations — see Chapter 3 for a discussion of identifying performance
obligations. However, we believe it would be rare for custodial services included in a bill-and-hold arrangement to
be considered immaterial in the context of the contract even if the standalone selling price of such services is
quantitatively small. In order to apply bill-and-hold accounting, the reason for the arrangement must be
substantive, which indicates that the custodial services are likely important to the customer and thus qualitatively
material.
6.9 CUSTOMER ACCEPTANCE
FASB REFERENCES
ASC 606-10-25-30(e) and ASC 606-10-55-85 through 55-88
A customer’s acceptance of an asset may indicate that the customer has obtained control of the asset. Customer
acceptance clauses allow a customer to cancel a contract or require an entity to take remedial action if a good or
service does not meet agreed-upon specifications. An entity must consider such clauses when evaluating when a
customer obtains control of a good or service.
If an entity can objectively determine that control of a good or service has been transferred to the customer in
accordance with the agreed-upon specifications in the contract, then customer acceptance is a formality that would
not affect the entity’s determination of when the customer has obtained control of the good or service. An entity
would determine whether the criteria related to customer acceptance have been met before receiving confirmation of
the customer’s acceptance if, for example, the customer acceptance clause is based on meeting specified size and
weight characteristics of the product. An entity’s experience with contracts for similar goods or services may provide
evidence that a good or service provided to the customer is in accordance with the agreed-upon specifications in the
contract. If revenue is recognized before customer acceptance (for example, upon delivery), the entity still must
consider if there are any remaining performance obligations (for example, installation or maintenance of the
equipment) and evaluate whether to account for them separately.
If an entity cannot objectively determine that the good or service provided to the customer is in accordance with the
agreed-upon specifications in the contract, then the entity would not be able to conclude that the customer has
obtained control until the entity receives the customer’s acceptance. That is because the entity cannot determine that
the customer can direct the use of, and obtain substantially all of the remaining benefits from, the good or service
until the customer’s acceptance is received.
Additionally, if an entity delivers products to a customer for trial or evaluation purposes and the customer is not
committed to pay any consideration until the trial period lapses, then control of the product is not transferred to the
customer until either the customer accepts the product, or the trial period lapses.
REVENUE RECOGNITION UNDER ASC 606 179
CHAPTER 7 — OTHER TOPICS
7.1 OVERVIEW
This chapter includes a detailed discussion of certain other key concepts in ASC 606 that are critical in applying the
five-step revenue recognition model discussed in prior chapters. Those concepts include:
Principal versus agent considerations
Contract modification
Customer options for additional goods or services
Licensing
Onerous contracts
Contract costs
7.2 PRINCIPAL VERSUS AGENT CONSIDERATIONS
FASB REFERENCES
ASC 606-10-55-36 and 55-36A
ASC 606 includes guidance on performing a principal versus agent assessment when a third party is involved in providing
goods or services to a customer. An entity is a principal and therefore recognizes revenue on a gross basis if it controls
a good or service before transferring it to the customer. An entity is an agent and therefore recognizes revenue on a
net basis if it arranges for a good or service provided by another entity. The standard includes indicators and examples
to assist with the analysis
Presentation
and
Disclosures
Scope
Step 1:
Identify the
contract
with a
customer
Step 2:
Identify the
performance
obligations in
the contract
Step 3:
Determine
the
transaction
price
Step 4:
Allocate the
transaction price to
the performance
obligations
Step 5:
Recognize revenue
when or as the
performance
obligation is
satisfied
Other
Topics
REVENUE RECOGNITION UNDER ASC 606 180
DETERMINE THE NATURE OF AN ENTITY’S PROMISE IN A THREE-PARTY ARRANGEMENT
When a third party is involved in providing goods or services to a customer, an entity must determine whether the
nature of its promise is to:
Provide the specified goods or services itself — that is, the entity is a principal
Arrange for those goods or services to be provided by the third party — that is, the entity is an agent
To determine the nature of its promise, an entity must:
Identify the specified goods or services provided to the customer (for example, a right to a good or service
provided by a third party)
Assess whether it controls each specified good or service before it is transferred to the customer — see
Section 7.2.2 for discussion on control
BDO INSIGHTS — USING THE PRINCIPAL VERSUS AGENT GUIDANCE TO IDENTIFY THE CUSTOMER
The guidance in ASC 606 on performing a principal versus agent assessment is written from the viewpoint of the
intermediary entity that obtains a good or service from a third party and subsequently sells that good or service to a
customer. In that scenario, the entity may conclude either of the following:
It is the principal in which case the cost of the good or service procured from the third party will be reported as
an operating expense (that is, cost of goods sold or cost of services).
It is an agent in which case the cost of the good or service will be reported net in revenue.
However, in many cases the entity performing the principal versus agent assessment may be the party that provides
the good or service to a third party, who then transfers the good or service to an end customer. In that case, the
entity is considered a principal in the transaction because it controls the good or service before transferring it to
the interim buyer. In that fact pattern, the assessment focuses on whether the interim buyer or the end customer is
the entity’s customer. To identify its customer, the entity must assess whether its immediate buyer is a principal or
an agent in the sale to the end customer.
If the entity concludes that the interim buyer is the principal in the sale to the end customer, then its customer
is the interim buyer, and the entity’s revenue is the amount charged to the interim buyer. Any subsequent
increase in price charged to the end customer by the interim buyer is not reflected in the entity’s income
statement.
If the entity concludes that the interim buyer is acting as the entity’s agent, and the end customer is the entity’s
customer, then the amount charged to the end customer by the interim buyer is recognized as the entity’s
revenue, and any difference between that amount and the amount charged to the interim buyer is reflected as
an operating expense (that is, cost of goods sold, cost of services, or selling expense). However, when an entity
does not have visibility into the price charged by the interim buyer to the end customer, that unknown amount is
excluded from the entity’s revenue (that is, the entity does not estimate the amount charged by the interim
buyer to the end customer).
REVENUE RECOGNITION UNDER ASC 606 181
BDO INSIGHTS — INTERRELATIONSHIP BETWEEN IDENTIFYING THE CUSTOMER (STEP 1) AND PERFORMANCE
OBLIGATIONS (STEP 2)
The first step in applying the principal versus agent analysis is appropriately identifying the good or service that an
entity has promised to transfer to the customer (the specified good or service). In some arrangements,
identification of the good or service that an entity has promised to transfer may inform the conclusion about which
party is the entity’s customer. That is, the identification of the entity’s obligations may be intertwined with the
identification of the entity’s customer(s).
For example, consider a technology platform entity that has developed an app to connect car drivers to end
customers to receive car rides. The end customers download the app at no cost to connect with car drivers and
make payments to the technology platform entity. If the entity determines that the nature of its promise is to
connect the driver to the end customer (rather than to provide ride services to the end customer), then the entity
would conclude that its customer is the driver (not the end customer). Reaching a conclusion about identifying the
obligation(s) and the customers requires the application of professional judgment, based on the facts and
circumstances.
7.2.1 Unit of Account
FASB REFERENCES
ASC 606-10-55-36
An entity must determine whether it is a principal or an agent for each specified good or service promised to the
customer. A specified good or service is a distinct good or service (or a distinct bundle of goods or services) provided to
the customer (see Chapter 3 for discussion on distinct goods or services).
CONTRACTS WITH MULTIPLE SPECIFIED GOODS OR SERVICES
If a contract with a customer includes multiple specified goods or services, an entity could be a principal for some
specified goods or services and an agent for others. See Example 7-6 in this chapter.
Note that the guidance on principal versus agent considerations in ASC 606 refers to the term “specified good or
service” transferred to the customer, rather than “performance obligation.” In BC10 of ASU 2016-08, the FASB stated
that the use of the term “performance obligation” would have been confusing if the entity is an agent because an
agent’s performance obligation is to arrange for the other party to provide goods or services to the customer; the
agent does not promise to provide the goods or services itself to the end customer. Accordingly, the good or service
provided to the end customer is not the performance obligation of the agent.
REVENUE RECOGNITION UNDER ASC 606 182
7.2.2 Assessment of Control
FASB REFERENCES
ASC 606-10-55-37, ASC 606-10-55-37A, and ASC 606-10-55-38
The following diagram illustrates the key considerations in assessing whether an entity controls the specified good or
service transferred to a customer and the related accounting outcome:
Control of an asset refers to the ability to both:
Does an entity control the specified good or service before it is
transferred to a customer?
The entity is an
agent and
recognizes revenue
and associated
costs on a net
basis.
The entity is the
principal and
recognizes revenue
and associated costs
on gross basis.
Direct the use of the
asset
Obtain substantially all
of the remaining
benefits from the asset
Indicators of transfer of control:
The entity has a present right to payment for the asset.
The customer has legal title to the asset.
The entity has transferred physical possession of the
asset.
The customer has the significant risks and rewards of
ownership of the asset.
The customer has accepted the asset.
Indicators an entity controls the specified good or service
before it is transferred to the customer:
The entity is primarily responsible for fulfilling the
promise to provide the specified good or service.
The entity has inventory risk.
The entity has pricing discretion.
No
Yes
REVENUE RECOGNITION UNDER ASC 606 183
An entity is:
A principal if it controls the specified good or service before that good or service is transferred to a customer. An
entity that is a principal recognizes revenue when (or as) it satisfies a performance obligation in the gross amount of
consideration to which it expects to be entitled in exchange for the good or service transferred.
An agent if the entity’s performance obligation is to arrange for the provision of the specified good or service by a
third party. An entity that is an agent does not control the specified good or service provided by a third party before
that good or service is transferred to the customer. An entity that is an agent recognizes revenue when (or as) it
satisfies a performance obligation of any fee or commission to which it expects to be entitled in exchange for
arranging for the specified goods or services provided by the other party. That fee or commission may be the net
amount of consideration that the entity retains after paying the third party the consideration received in exchange
for the goods or services provided by that party.
When a third 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 good or another asset from the third party that it then transfers to the customer (see Example 7-4 in this chapter)
A right to a service performed by the third party, which gives it the ability to direct that third party to provide the
service to the customer on its behalf (see Example 7-3 in this chapter)
A good or service from the third party that it then combines with other goods or services in providing the specified
good or service to the customer (see Example 7-2 in this chapter)
7.2.2.1 Significant Integration Service
An entity controls the specified good or service before that good or service is transferred to the customer if the entity
provides a significant service of integrating goods or services (see Section 3.3.2.1 for a discussion of significant
integration services) provided by a third party into the specified good or service for which the customer has
contracted. In that fact pattern, the entity first obtains control of the inputs to the specified good or service (which
include goods or services from third parties) and directs their use to create the combined output that is the specified
good or service. For example, an entity that is a principal in providing project management service to a customer may
combine specialized equipment manufactured by a third party with the entity’s project management service.
7.2.2.2 Effect of Legal Title on Assessment of Control
An entity does not necessarily control a specified good if the entity obtains legal title to that good only momentarily
before legal title is transferred to a customer, which is sometimes referred to as a “flash title.”
FLASH TITLE TO A GOOD OR SERVICE
A flash title to a good or service is not a conclusive indicator of control in and of itself.
7.2.2.3 Third Party Engaged by the Principal
An entity that is a principal may satisfy its performance obligation to provide the specified good or service itself or it
may engage another party (for example, a subcontractor) to satisfy some or all of the performance obligation on its
behalf.
If a third party assumes an entity’s performance obligations and contractual rights in the contract so that the entity is
no longer obliged to satisfy the performance obligation to transfer the specified good or service to the customer (that
is, the entity is no longer acting as the principal), the entity does not recognize revenue for that performance
obligation. Instead, the entity evaluates whether to recognize revenue for satisfying a performance obligation to obtain
a contract for the other party (that is, whether the entity is acting as an agent).
REVENUE RECOGNITION UNDER ASC 606 184
7.2.3 Indicators of Control
FASB REFERENCES
ASC 606-10-55-39
In some instances, it may not be clear whether an entity controls a good or service before transferring it to a
customer. To assist with the assessment of control, ASC 606 provides the following non-exclusive list of indicators that
an entity controls the specified good or service before it is transferred to the customer (and is therefore the principal
for the specified good or service):
INDICATORS OF CONTROL DO NOT OVERRIDE THE CONTROL PRINCIPLE
The indicators of control do not override the control principle (see Section 6.2.1 for discussion on the notion of
control) but rather assist entities in evaluating the control principle. The indicators may be more or less relevant to
the assessment of control depending on the nature of the specified good or service and the terms and conditions of
the contract. Additionally, different indicators may provide more persuasive evidence in different contracts.
Primary
Responsibility
The entity is primarily responsible for fulfilling the promise to provide the specified
good or service. This typically includes responsibility for the acceptability of the
specified good or service (for example, primary responsibility for the good or service
meeting customer specifications). If the entity is primarily responsible for fulfilling the
promise to provide the specified good or service, this may indicate that the other party
involved in providing the specified good or service is acting on the entity’s behalf.
The entity has inventory risk before the specified good or service has been transferred
to a customer or after transfer of control to the customer, for example, if the customer
has a right of return. As an example, if the entity obtains, or commits to obtain, the
specified good or service before obtaining a contract with a customer, that may indicate
that the entity has the ability to direct the use of and obtain substantially all of the
remaining benefits from the good or service before it is transferred to the customer.
The entity has discretion in establishing the price for the specified good or service.
Establishing the price that the customer pays for the specified good or service may
indicate that the entity has the ability to direct the use of and obtain substantially all of
the remaining benefits from that good or service. However, an agent can have
discretion in establishing prices in some cases. For example, an agent may have some
flexibility in setting prices to generate more revenue from its service of arranging for
goods or services provided by other parties to customers.
Inventory Risk
Discretion in
Pricing
REVENUE RECOGNITION UNDER ASC 606 185
BDO INSIGHTS — INDICATORS OF CONTROL ARE HELPFUL (NOT NECESSARILY CONCLUSIVE)
The control indicators in ASC 606 serve only to help an entity determine whether it controls the good or service
being transferred if it is not obvious from the terms of the arrangement. A weighted assessment of the indicators
themselves does not necessarily result in a conclusion of principal or agent. Rather, the conclusive determination of
principal or agent is made based on the notion of control.
In addition, the principal versus agent assessment focuses on the nature of the performance obligations and
whether the entity controls the good or service before transferring it to the end customer instead of determining
whether the entity is exposed to the risks and rewards of the transaction.
Reaching a conclusion about whether an entity is the principal or agent in a three-party revenue transaction
requires the application of professional judgment, based on the facts and circumstances.
EXAMPLE 7-1 (ADAPTED FROM ASC 606-10-55-317 THROUGH 55-319): ARRANGING FOR THE PROVISION OF
GOODS OR SERVICES — ENTITY IS AN AGENT
An entity operates a website that enables end customers to purchase goods from a range of suppliers who deliver
the goods directly to the customers. Following are the key terms of the entity's contracts with suppliers:
The entity is entitled to a 10% commission on the sales price of the good purchased when an end customer
purchases a good via the entity’s website.
The supplier sets the prices. The entity’s website facilitates payment between the supplier and the customer.
The entity requires payment from end customers before processing orders on its website; all orders are
nonrefundable.
The entity has no further obligations to the end customer after arranging for the goods provided to the customer.
To determine whether the entity’s performance obligation is to provide the specified goods itself (that is, the entity
is a principal) or to arrange for those goods to be provided by the supplier (that is, the entity is an agent), the
entity identifies the specified good or service provided to the customer and assesses whether it controls that good
or service before the good or service is transferred to the customer.
The entity observes that the website it operates is a marketplace where suppliers offer their goods to end
customers for purchase. Accordingly, the entity determines that the specified goods provided to end customers that
use the website are the goods provided by the suppliers, and no other goods or services are promised to end
customers by the entity.
The entity concludes that it does not have the ability to direct the use of the goods transferred to the end
customers at any time because:
It cannot direct the goods to parties other than the end customer or prevent the supplier from transferring those
goods to the end customer.
It does not control the suppliers’ inventory of goods used to fulfill the orders placed by end customers using the
website.
Therefore, the entity concludes that it does not control the goods before they are transferred to end customers that
order goods using the website. In reaching that conclusion, the entity determines that the following indicators
provide further evidence that it does not control the specified goods before they are transferred to the end
customers.
The entity is neither obliged to provide the goods if the supplier fails to transfer the goods to the end customer
nor responsible for the acceptability of the goods. Rather, the supplier is primarily responsible for fulfilling the
promise to provide the goods to the end customer.
REVENUE RECOGNITION UNDER ASC 606 186
The entity does not commit to obtain the goods from the supplier before the goods are purchased by the end
customer and does not accept responsibility for any damaged or returned goods. Therefore, the entity does not
take inventory risk at any time before or after the goods are transferred to the customer.
The sales price is set by the supplier and the entity does not have discretion in establishing prices for the
supplier’s goods.
Therefore, the entity concludes that it is an agent and that its performance obligation is to arrange for the
provision of goods by the supplier to the end customer. The entity satisfies its promise to arrange for the goods
provided by the supplier to the end customer when the customer purchases the goods. At that point in time, the
entity recognizes revenue equal to the agency commission to which it is entitled.
EXAMPLE 7-2 (ADAPTED FROM ASC 606-10-55-320 THROUGH 55-324): PROMISE TO PROVIDE GOODS OR
SERVICES — ENTITY IS A PRINCIPAL
An entity enters a contract with a customer to deliver equipment with unique specifications under the following
terms:
The entity and the customer develop the specifications for the equipment and negotiate the selling price.
The entity communicates those agreed upon specifications for the equipment to a third-party supplier that the
entity contracts with to manufacture the equipment. The entity and the supplier agree on a price paid by the
entity for that equipment. The entity’s profit is based on the difference between the sales price negotiated with
the customer and the price charged by the supplier.
The entity arranges to have the supplier deliver the equipment directly to the customer.
Upon delivery of the equipment to the customer, the entity is contractually required to pay the supplier the
price agreed to by the entity and the supplier for manufacturing the equipment.
The entity invoices the customer for the agreed-upon price with 30-day payment terms.
The contract between the entity and the customer requires the customer to seek remedies for defects in the
equipment from the supplier under the supplier’s warranty. However, the entity is responsible for any
corrections to the equipment required resulting from errors in specifications.
To determine whether the entity’s performance obligation is to provide the specified goods or services itself (that
is, the entity is a principal) or to arrange for those goods or services provided by another party (that is, the entity is
an agent), the entity first identifies the specified good or service provided to the customer and then assesses
whether it controls that good or service before the good or service is transferred to the customer.
The entity concludes that it has promised to provide the customer with specialized equipment designed by the
entity:
Although it has subcontracted the manufacturing of the equipment to the supplier, the design and manufacturing
of the equipment are not distinct because they are not separately identifiable (that is, there is a single
performance obligation).
It is responsible for the overall management of the contract (for example, by making sure the manufacturing
service conforms to the specifications) and therefore provides a significant service of integrating those items into
the combined output — the specialized equipment — for which the customer has contracted.
The activities pertaining to the design and overall management of the contract are highly interrelated with the
equipment. If necessary, modifications to the specifications are identified as the equipment is manufactured,
the entity is responsible for developing and communicating revisions to the supplier and for making sure any
associated rework required conforms with the revised specifications.
Based on the above analysis, the entity identifies the specified good provided to the customer as the specialized
equipment.
REVENUE RECOGNITION UNDER ASC 606 187
The entity concludes that it controls the specialized equipment before that equipment is transferred to the
customer based on the below:
The entity provides the significant integration service necessary to produce the specialized equipment.
The entity directs the use of the supplier’s manufacturing service as an input in creating the combined output
that is the specialized equipment.
Even though the supplier delivers the specialized equipment to the customer, the supplier has no ability to direct
its use. The terms of the contract between the entity and the supplier preclude the supplier from using the
specialized equipment for another purpose or directing it to another customer.
The entity obtains the remaining benefits from the specialized equipment by being entitled to the consideration
in the contract from the customer.
Based on the above analysis, the entity concludes that it is a principal in the transaction. The entity does not
consider the indicators of control (see Section 7.2.3) because the evaluation is conclusive without consideration of
the indicators.
The entity recognizes revenue in the gross amount of consideration to which it is entitled from the customer in
exchange for the specialized equipment.
EXAMPLE 7-3 (ADAPTED FROM ASC 606-10-55-324A THROUGH 55-324G): PROMISE TO PROVIDE GOODS OR
SERVICES — ENTITY IS A PRINCIPAL
An entity enters a contract with a customer to provide cleaning services at the customer’s offices under the
following terms:
The entity and the customer agree on the scope of the services and negotiate the price.
The entity is responsible for making sure the services are performed in accordance with the terms and conditions
in the contract.
The entity invoices the customer monthly for the agreed-upon price with 15-day payment terms.
The entity routinely engages third-party service providers to provide cleaning services to its customers. When the
entity obtains a contract from a customer, the entity enters a contract with one of those third-party service
providers, which directs the service provider to perform cleaning services for the customer. While the payment
terms in the contracts with the service providers generally are aligned with the payment terms in the entity’s
contracts with customers, the entity is obliged to pay the service provider even if the customer fails to pay.
To determine whether the entity is a principal or an agent, the entity first identifies the specified good or service
provided to the customer and then assesses whether it controls that good or service before the good or service is
transferred to the customer.
The entity observes that the specified services provided to the customer are the cleaning services for which the
customer contracted and that no other goods or services are promised to the customer. While the entity obtains a
right to cleaning services from the service provider after entering the contract with the customer, that right is not
transferred to the customer. That is, the entity retains the ability to direct the use of and obtain substantially all
the remaining benefits from that right. For example, the entity can decide whether to direct the service provider to
provide the cleaning services for that customer, or for another customer, or at its own facilities. The customer does
not have a right to direct the service provider to perform services that the entity has not agreed to provide.
Therefore, the right to cleaning services obtained by the entity from the service provider is not the specified good
or service in its contract with the customer.
The entity concludes that it controls the specified services before they are provided to the customer. The entity
obtains control of a right to cleaning services after entering into the contract with the customer but before those
services are provided to the customer. The terms of the entity’s contract with the service provider give the entity
the ability to direct the service provider to provide the specified services on the entity’s behalf. Additionally, the
REVENUE RECOGNITION UNDER ASC 606 188
entity concludes that the following indicators of control (see Section 7.2.3) provide further evidence that the entity
controls the cleaning services before they are provided to the customer:
The entity is primarily responsible for fulfilling the promise to provide cleaning services. Although the entity has
hired a service provider to perform the services promised to the customer, it is the entity itself that is
responsible to make sure the services are performed and are acceptable to the customer. That is, the entity is
responsible for fulfillment of the promise in the contract, regardless of whether the entity performs the services
itself or engages a third-party service provider to perform the services.
The entity has discretion in setting the price for the services to the customer.
The entity observes that it has mitigated its inventory risk with respect to the cleaning services as it does not
commit itself to obtain the services from the service provider before obtaining the contract with the customer.
Nevertheless, the entity concludes that it controls the office cleaning services before they are provided to the
customer based on the evidence stated in the paragraph above.
Therefore, the entity is a principal in the transaction and recognizes revenue equal to the consideration to which it
is entitled from the customer in exchange for the cleaning services. The entity recognizes amounts paid to the
third-party service provider as cost of sales.
EXAMPLE 7-4 (ADAPTED FROM ASC 606-10-55-325 THROUGH 55-329): PROMISE TO PROVIDE GOODS OR
SERVICES — ENTITY IS A PRINCIPAL
An entity, an airline ticket reseller, negotiates with major airlines to purchase tickets at reduced rates compared
with the price of tickets sold directly by the airlines to the public. The entity agrees to buy a specific number of
tickets and must pay for those tickets regardless of whether it is able to resell them. The reduced rate paid by the
entity for each ticket purchased is negotiated and agreed in advance.
The entity enters contracts with its customers to resell the tickets. Following are the key terms of its arrangements
with its customers:
The entity determines the prices at which the airline tickets will be sold to its customers.
The entity sells the tickets and collects the consideration from customers when the tickets are purchased.
The entity assists the customers in resolving complaints about the service provided by the airlines. However,
each airline (not the entity) is responsible for fulfilling obligations from the ticket, including remedies to a
customer for dissatisfaction with the service.
To determine whether the entity’s performance obligation is to provide the specified goods or services itself (that
is, the entity is a principal) or to arrange for those goods or services provided by another party (that is, the entity is
an agent), the entity first identifies the specified good or service provided to the customer and then assesses
whether it controls that good or service before the good or service is transferred to the customer.
The entity concludes that with each ticket that it commits itself to purchase from the airline, it obtains control of a
right to fly on a specified flight (in the form of a ticket) that the entity then transfers to one of its customers.
Therefore, the entity determines that the specified good or service provided to its customer is that right to a seat
on a specific flight that the entity controls. The entity observes that no other goods or services are promised to the
customer.
The entity controls the right to each flight before it transfers that specified right to one of its customers because:
The entity has the ability to direct the use of that right by deciding whether to use the ticket to fulfill a contract
with a customer and if so, which contract it will fulfill.
The entity has the ability to obtain the remaining benefits from that right by either reselling the ticket and
obtaining all of the proceeds from the sale or, alternatively, using the ticket itself.
REVENUE RECOGNITION UNDER ASC 606 189
The following indicators of control (see Section 7.2.3) also provide relevant evidence that the entity controls each
specified right (ticket) before it is transferred to the customer.
The entity has inventory risk on the ticket because the entity committed itself to obtain the ticket from the
airline before obtaining a contract with a customer to purchase the ticket. This is because the entity is obliged
to pay the airline for that right regardless of whether it is able to obtain a customer to resell the ticket to or
whether it can obtain a favorable price for the ticket.
The entity establishes the price that the customer will pay for the specified ticket.
Therefore, the entity concludes that it is a principal in the transactions with customers. The entity recognizes
revenue in the gross amount of consideration to which it is entitled in exchange for the tickets transferred to the
customers.
7.2.4 Determining Whether the Specified Good or Service is the Right to a Good or Service or the
Underlying Good or Service
It could be challenging to determine when the specified good or service is the right to a good or service and when it is
the underlying good or service itself in a principal versus agent evaluation.
For example, in Example 7-4, it could be difficult to determine whether the specified good or service is a right to the
flight (the ticket) or the flight itself. In BC26 through BC28 of ASU 2016-08, the FASB stated that assessing whether the
entity controls a right to a good or service is important to the principal versus agent evaluation and observed that
there may be judgment involved in identifying the specified good or service in some cases. The FASB highlighted
certain distinctions between the fact pattern in Examples 7-3 and 7-4:
In Example 7-4, the ticket reseller itself does not transport the customers and it cannot change or modify the
service (for example, change the flight time or destination). The ticket reseller does not obtain a customer and then
obtain a flight service provider to fulfill its performance obligation to the customer to transport the customer from
one location to another. Rather, the ticket reseller obtains tickets before a customer is identified for each of those
tickets. The tickets represent specified rights to fly on specific flights operated by a third-party airline. The ticket
reseller then transfers that specific right to the customer. Therefore, the customer obtains from the ticket reseller
a specified asset (the ticket representing the right to fly on a specified flight) that the ticket reseller controlled.
The ticket reseller controls a right to fly, which is an asset because it can:
• Direct the use of the ticket by using the ticket itself, selling the ticket to any customer it wishes, or letting the
ticket expire unused.
• Obtain substantially all the remaining benefits of the ticket by either consuming the right or obtaining all of the
cash flows from sale of that right.
In contrast, Example 7-3 concludes that the specified good or service is the underlying cleaning services rather than
a right to those services. In that example, the entity obtains the contract with the customer to provide the cleaning
services before it engages a subcontractor (the third-party cleaning services provider) to perform those services.
While the entity enters a contract to obtain cleaning services from the subcontractor after entering into the
contract with the customer (but before the cleaning services are provided to the customer), the right to the
subcontractor’s services is not transferred to the customer. The entity retains control over that right (that is, the
entity retains the right to utilize the services from the subcontractor as it sees fit — it can utilize its right to
cleaning services to fulfill the customer contract or another customer contract or to service its own facilities). The
customer does not obtain control of the entity’s right to direct the subcontractor. The customer has contracted with
the entity for cleaning services and the customer is indifferent as to whether the subcontractor, the entity, or any
other subcontractor carries out the cleaning services as long as those services are in accordance with the
contractual terms. Conversely, in Example 7-4, the customer is not indifferent as to which ticket the ticket reseller
transfers to it. The customer wants the ticket reseller to transfer a specific right that the customer will then control
(that is, a ticket for a specific flight).
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EXAMPLE 7-5 (ADAPTED FROM ASC 606-10-55-330 THROUGH 55-334): ARRANGING FOR THE PROVISION OF
GOODS OR SERVICES — ENTITY IS AN AGENT
An entity sells vouchers that entitle customers to future meals at specified restaurants. The selling price of the
voucher provides the customer with a significant discount when compared with the normal selling prices of the
meals (for example, a customer pays $10 for a voucher that entitles the customer to a meal at a restaurant that
would otherwise cost $20). Following are the key terms of the three-party arrangement:
The entity purchases vouchers only as they are requested by the customers. That is, the entity does not purchase
or commit itself to purchase vouchers in advance of the sale of a voucher to a customer.
The entity sells the nonrefundable vouchers through its website.
The entity and the restaurants jointly determine the selling price of the vouchers.
Under the terms of its contracts with the restaurants, the entity is entitled to 20% of the selling price when it
sells the voucher.
The entity assists the customers in resolving complaints about the meals and has a buyer satisfaction program.
However, the restaurant is responsible for fulfilling obligations from the voucher, including remedies to a
customer for dissatisfaction with the service.
To determine whether the entity is a principal or an agent, the entity first identifies the specified good or service to
be provided to the customer and assesses whether it controls the specified good or service before that good or service
is transferred to the customer.
The entity observes that a customer obtains a voucher for the restaurant that the customer selects. The entity does
not engage the restaurants to provide meals to customers on the entity’s behalf. Therefore, the entity concludes
that the specified good or service to be provided to the customer is the right to a meal (in the form of a voucher) at
a specified restaurant which the customer purchases and can use itself or transfer to another person rather than
purchasing the meal itself. The entity also observes it promises no other goods or services (other than the vouchers)
to the customers.
The entity concludes that it does not control the voucher (right to a meal) at any time. In reaching this conclusion,
the entity principally considers the following:
The vouchers are created only at the time they are transferred to the customers and therefore do not exist
before that transfer. Consequently, the entity does not at any time have the ability to direct the use of the
vouchers or obtain substantially all of the remaining benefits from the vouchers before they are transferred to
customers.
The entity neither purchases nor commits itself to purchase vouchers before they are sold to customers. The
entity also has no responsibility to accept any returned vouchers. Therefore, the entity does not have inventory
risk on the vouchers.
Based on the above analysis, the entity concludes that it is an agent in the arrangement to sell the vouchers. The
entity recognizes revenue in the net amount of consideration to which the entity will be entitled in exchange for
arranging for the restaurants to provide vouchers to customers for the restaurants’ meals, which is the 20%
commission it is entitled to upon the sale of each voucher.
EXAMPLE 7-6 (ADAPTED FROM ASC 606-10-55-334A THROUGH 55-334F): ENTITY IS A PRINCIPAL AND AN AGENT
IN THE SAME CONTRACT
An entity sells services to assist its customers in more effectively targeting potential recruits for open job positions.
The entity performs several services itself, for example, interviewing candidates and performing background
checks. Below are the key terms of the three-party arrangement:
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The customer agrees to obtain a license to access a third-party’s database of background information on
potential recruits as part of the contract between the entity and the customer.
The entity arranges for this license with the third party, but the customer contracts directly with the database
provider for the license.
The database provider sets the price charged to the customer for the license and is responsible for providing
technical support and credits to which the customer may be entitled for service downtime or other technical
issues.
The entity collects payment on behalf of the third-party database provider as part of its overall invoicing to the
customer.
To determine whether the entity is a principal or an agent, the entity first identifies the specified goods or services
provided to the customer and then assesses whether it controls those goods or services before they are transferred
to the customer.
Assume that the entity concludes that its recruitment services and the database access license are each distinct —
see Chapter 3 for a related discussion. Accordingly, there are two specified goods or services provided to the
customer:
Access to the third-party’s database
Recruitment services
The entity concludes that it does not control the access to the third-party database before it is provided to the
customer. The entity does not have the ability at any time to direct the use of the license because the customer
contracts for the license directly with the third-party database provider. The entity does not control access to the
provider’s database. For example, the entity cannot grant access to the database to a party other than the
customer or prevent the database provider from providing access to the customer.
In reaching that conclusion, the entity also considers the following indicators of control (see Section 7.2.3) that
provide further evidence that it does not control access to the database before that access is provided to the
customer:
The entity is not responsible for fulfilling the promise to provide the database access service. The customer
contracts for the license directly with the third-party database provider, and the database provider is
responsible for the acceptability of the database access (for example, by providing technical support or service
credits).
The entity does not have inventory risk because it does not purchase or commit to purchase the database access
before the customer contracts for database access directly with the database provider.
The entity does not have discretion in setting the price for the database access with the customer because the
database provider sets that price.
Based on the above analysis, the entity concludes that it is an agent in relation to the third-party’s database
service.
In contrast, the entity concludes that it is the principal in relation to the recruitment services because the entity
performs those services itself and no other party is involved in providing those services to the customer.
BDO INSIGHTS — PRINCIPAL VERSUS AGENT ANALYSIS IS COMPLEX
In practice, determining whether an entity is acting as a principal or an agent can be sometimes difficult and may
require significant judgment, based on the facts and circumstances. We expect those judgments to continue to be
challenging when applying the guidance to certain complex arrangements. For example, transactions involving
virtual goods and services are often executed in milliseconds and involve multiple counterparties. Consequently,
control over a virtual good may transfer almost instantaneously, making it challenging to assess which party controls
that good before it is transferred to the end customer.
REVENUE RECOGNITION UNDER ASC 606 192
Assessing whether an entity is acting as a principal, or an agent may also be complex in situations in which two
parties collaborate to deliver a product on demand to a customer. Consider an example in which Entity A installs
water filtration systems on Entity B’s retail premises, where the product (filtered water) is delivered on demand by
filtering water obtained from a municipal water supplier, with Entity B receiving a portion of the proceeds from the
customer. Neither party would appear to control the underlying good (the water) before delivery to the customer,
so assessing which entity is acting as the principal or the agent is challenging. We believe a principal must be
identified in any three-party revenue transaction; that is, gross revenue must be presented by at least one party in
a transaction even if significant collaboration exists with other entities in delivering an underlying good or service.
BDO INSIGHTS — SIGNIFICANCE OF CONTRACTS IN PRINCIPAL VERSUS AGENT ANALYSIS
An entity may need to focus on the precise contractual terms in a three-party revenue transaction to determine the
nature of the promises made (that is, what each party is providing) and the consideration earned by each party. In
determining which party controls the good or service transferred to the end customer, we generally believe the
existence of a contract with the end customer is a strong indicator that the counterparty controls the good or
service transferred to the end customer. However, determining whether an entity is the principal or agent requires
the application of professional judgment, based on the facts and circumstances.
BDO INSIGHTS — ‘DROP SHIPMENT’ ARRANGEMENTS
‘Drop shipment’ arrangements illustrate the complexity of the principal versus agent analysis. Drop shipping is a
supply chain management technique in which an entity does not keep physical stock of the goods it sells; it simply
arranges for the sale between a customer and its supplier, and the supplier ships the good directly to the customer.
This type of arrangement is becoming more common in the online retail environment, as it allows online retailers to
keep less physical inventory on hand while still servicing their customers. In such instances, physical possession and
legal title are likely less relevant in establishing whether the retailer who facilitates the shipment between its
supplier and the end customer is a principal or an agent in the transaction. An entity must carefully consider other
factors in determining whether it is acting as a principal or an agent in a drop-ship arrangement, including:
Does the entity have latitude in establishing price?
Does the entity only receive a fixed fee for establishing the relationship between the supplier and the customer?
Who is responsible for customer satisfaction and addressing customer complaints, for example, in the case of
product quality issues or returns?
Are the goods customized or interchangeable for other goods?
Which entity has the primary (or greater) responsibility towards the customer that receives the goods?
Which party does the customer think it is buying from?
All of the above factors may inform the analysis of whether the entity controls the good (that is, whether the entity
can direct the use of and derive substantially all of the benefits from the good) before it is transferred to the
customer.
REVENUE RECOGNITION UNDER ASC 606 193
SEC STAFF GUIDANCE
Remarks before the 2018 AICPA Conference on Current SEC and PCAOB Developments
Sheri L. York, Professional Accounting Fellow, Office of the Chief Accountant
December 10, 2018
The SEC staff discussed a preclearance related to a drop shipment arrangement in which a
distributor, the registrant, never obtained physical possession of the goods because the goods
were shipped directly from the manufacturer to the customer. In that fact pattern, the
distributor maintained inventory for the majority of the goods sold. However, certain
specialized goods were shipped by the manufacturer directly to the customer due to regulatory
reasons. The SEC staff did not object to the conclusion that the distributor controlled the
specialized goods before it was transferred to the customer because the distributor had the
ability to direct the use of, and obtain substantially all of the remaining benefits from, the
goods. Additionally, the distributor had the primary responsibility for fulfillment and pricing
discretion. The SEC staff stated that the conclusion as to whether an entity is a principal or an
agent requires a consideration of the definition of control, often including consideration of the
indicators of control, of which inventory risk is only one of the possible indicators. In some
circumstances, physical possession will not coincide with control of a specified good.
7.3 CONTRACT MODIFICATIONS
7.3.1 Identifying Contract Modifications
FASB REFERENCES
ASC 606-10-25-10 and 25-11
A contract modification is defined as a change in the scope or price of a contract that is approved by the parties to
that contract. In some industries and jurisdictions, a contract modification may be described as a change order, a
variation, or an amendment. A contract modification exists when the parties to a contract approve a modification that
either creates new or changes existing enforceable rights and obligations of the parties to the contract. A contract
modification could be approved in writing, by oral agreement or implied by customary business practices.
Generally, an entity must continue to apply the guidance in ASC 606 to the existing contract until the contract
modification is approved. However, a contract modification may exist even though the parties to the contract have a
dispute about the scope or price of the modification or the parties have approved a change in the scope of the contract
but have not yet determined the corresponding change in price. An entity must consider all relevant facts and
circumstances, including the terms of the contract and other evidence to determine whether the rights and obligations
that are created or changed by a modification are enforceable.
REVENUE RECOGNITION UNDER ASC 606 194
BDO INSIGHTS — DETERMINING WHETHER A CONTRACT MODIFICATION HAS OCCURRED
Determining whether a contract modification has occurred requires the application of professional judgment, based
on the facts and circumstance. Generally, the legal form of an amendment to an existing contract does not affect
the applicability of contract modification guidance. For example, contract modification guidance may be applicable
if an amendment to a contract is legally structured by terminating the existing contract and executing a new
contract (rather than executing an amendment to the original contract).
UNPRICED CHANGE ORDERS
If the parties to a contract have approved a change in the scope of the contract but have not yet determined the
corresponding change in price, an entity must estimate the change to the transaction price arising from the
modification in accordance with the guidance on estimating variable consideration and constraining estimates of
variable consideration (see Section 4.3 for a discussion of estimating the transaction price, including variable
consideration).
REVENUE RECOGNITION UNDER ASC 606 195
7.3.2 Accounting for Contract Modifications
FASB REFERENCES
ASC 606-10-25-12 and 25-13
The following diagram provides an overview of the accounting for contract modifications:
Are some remaining goods
or services distinct from
the goods or services
transferred on or before
the date of the
modification?
Account for the modification as if it were a
part of the existing contract, which may
result in a cumulative catch-up adjustment
at the date of the modification.
Does the scope of the
contract increase because
of the addition of
promised goods or services
that are distinct?
Are all remaining goods or
services distinct from the
goods or services
transferred on or before
the date of the
modification?
Account for the modification as if it were a
termination of the existing contract, and
the creation of a new contract, which
results in prospective adjustments to the
accounting for the existing contract.
Amount of consideration (including
contract liability) is reallocated to the
remaining performance obligations.
Account for the
modification as a
separate contract,
which results in no
adjustment to the
accounting for the
existing contract.
Yes
No
No
Yes
No
Yes
Yes
No
Account for the
modification as a
combination of the
termination of the existing
contract, and the creation
of a new contract and a
part of the existing
contract.
Does the price of the contract increase by
an amount of consideration that reflects
the SSP of the additional promised goods or
services?*
*Including any appropriate adjustments to that SSP to reflect the circumstances of the particular contract
REVENUE RECOGNITION UNDER ASC 606 196
A contract modification is accounted for as a separate contract — and does not affect the accounting for the existing
contract in any way — if both of the following conditions are met:
The scope of the contract changes due to the addition of promised goods or services that are distinct
The price of the contract increases by an amount of consideration that reflects the entity’s standalone selling price
of the additional promised goods or services, including any appropriate adjustments to that price to reflect the
circumstances of the particular contract
If either of the two conditions stated above are not met, the accounting for the modification depends on whether the
promised goods or services under the existing contract that have not yet transferred at the date of the contract
modification (that is, the remaining goods or services) are distinct from any additional goods or services arising from
the contract modification. The following approaches are applicable based on whether the remaining goods or services
are distinct:
Termination of the existing contract and creation of a new contract — If the remaining goods and services are
distinct (or are distinct goods or services that constitute a series), the contract modification is accounted for as a
replacement of the existing contract with a new contract. Any revenue and cost remaining unrecognized under the
existing contract, and revenues and costs from the contract modification, are combined and accounted for
prospectively as if it were a new contract. That is, there is no adjustment made to the revenue recognized to date
under the existing contract.
Continuation of the existing contract — If the remaining goods and services are not distinct, the contract
modification is accounted for as part of the existing contract which may result in an upward or downward
adjustment to revenue recognized to date under the existing contract (that is, a cumulative catch-up adjustment as
of the date of the contract modification).
Combination of the two approaches above — If some of the remaining goods or services are distinct and others are
not, then the entity must apply judgment to determine how to account for the effects of the modification on the
unsatisfied performance obligations in the modified contract. However, the approach must be consistent with the
objectives of the two approaches described above.
BDO INSIGHTS — ACCOUNTING FOR MODIFICATIONS WHEN ONLY SOME REMAINING PERFORMANCE OBLIGATIONS
ARE DISTINCT
Accounting for a modification in which only some (not all) of the remaining goods or services are distinct requires
the application of professional judgment, based on the facts and circumstances. Multiple approaches may be
acceptable as long as they are consistent with the objectives of the accounting approaches for a modification that is
a termination of the existing contract and creation of a new contract and a modification that is a continuation of
the existing contract. See Example 7-12 for an illustration of one acceptable approach.
While accounting for a modification that increases the scope (or promised goods or services) in a contract is more
straightforward, significant judgment may be required in accounting for a modification that includes changes other
than to increase the scope of the existing contract. See the following two examples adapted from ASC 606, which
illustrate the accounting for:
A modification to increase the quantity of goods sold to the customer (Example 7-7)
A modification to increase the quantity of goods sold to the customer and provide a concession related to the goods
already delivered under the existing contract (Example 7-8)
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EXAMPLE 7-7 (ADAPTED FROM ASC 606-10-55-111 THROUGH 55-116): MODIFICATION OF A CONTRACT FOR
GOODS — ADDITIONAL GOODS FOR A PRICE THAT REFLECTS THE STANDALONE SELLING PRICE
An entity enters a contract with a customer to sell 120 goods for $12,000 (that is, $100 per good). The goods are
transferred to the customer over a six-month period. Assume that the entity transfers control of each product at a
point in time. After the entity has transferred control of 60 goods to the customer, the contract is modified to
require the delivery of an additional 30 goods (a total of 150 identical goods) to the customer.
Assume that the contract modification provides that the price for the additional 30 goods is an additional $2,850
(that is, $95 per good).
At the date of contract modification, the entity determines that:
The pricing for the additional goods reflects the standalone selling price of the goods at that date.
The additional products are distinct from the goods provided under the original contract.
Therefore, the entity accounts for the contract modification for the additional 30 goods as in effect a new and
separate contract for future goods that does not affect the accounting for the existing contract. The entity
recognizes revenue of $100 per good for the 120 goods in the original contract and $95 per good for the 30 goods in
the new contract.
EXAMPLE 7-8 (ADAPTED FROM ASC 606-10-55-111 THROUGH 55-116): MODIFICATION OF A CONTRACT FOR
GOODS — ADDITIONAL GOODS FOR A PRICE THAT DOES NOT REFLECT THE STANDALONE SELLING PRICE
Assume that in the fact pattern in Example 7-7, the parties agree on a price of $80 per good as the price for the
additional 30 goods. However, after that negotiation, the customer discovers that the initial 60 goods transferred to
the customer contained minor defects that were unique to those delivered goods. The entity and customer agree
that:
The entity will issue a partial credit of $15 per item to compensate the customer for the poor quality of those 60
goods (that is, $900 credit for 60 goods).
The credit of $900 will be incorporated into the price that the entity charges for the additional 30 goods.
As a result, the contract modification specifies that the price for the additional 30 goods is $1,500 (or $50 per
good), which consists of the agreed-upon price for the additional 30 goods of $2,400 (or $80 per good), less the
credit of $900.
At the time of modification:
The entity recognizes the $900 credit as a reduction of the transaction price and, therefore, as a reduction of
revenue for the initial 60 goods (each a distinct performance obligation) transferred. This is because the $900
concession relates to the 60 goods previously delivered.
In evaluating the contract modification for the sale of the additional 30 goods, the entity determines that:
• The remaining goods delivered are distinct from those already transferred.
• The negotiated price of $80 per good does not reflect the standalone selling price of the additional goods.
Therefore, the entity accounts for the contract modification as a termination of the original contract and the
creation of a new contract.
As a result, the amount of revenue recognized for each of the remaining goods is a blended price of $93.33 (which is
calculated as [($100× 60 goods not yet transferred under the original contract) + ($80× 30 goods transferred under
the contract modification)] divided by 90 remaining goods).
REVENUE RECOGNITION UNDER ASC 606 198
EXAMPLE 7-9 (ADAPTED FROM ASC 606-10-55-117 THROUGH 55-124): CHANGE IN THE TRANSACTION PRICE
AFTER A CONTRACT MODIFICATION
On June 1, 20X0, an entity promises to transfer two distinct products, Products A and B, to a customer. Product A
transfers to the customer at contract inception and Product B transfers on March 1, 20X1.
The consideration in the contract includes fixed consideration of $1,000 and variable consideration that is estimated
at $200 at contract inception. Assume that both products have the same standalone selling price.
The entity includes its estimate of variable consideration in the transaction price because it concludes that it is
probable that a significant reversal in cumulative revenue recognized will not occur when the uncertainty related to
the variable consideration is resolved. Therefore, the transaction price for the contract is $1,200.
Assume that the criteria for the variable consideration allocation exception (see Section 5.5) are not met. Based on
the relative standalone selling prices of the two products, the entity allocates the transaction price of $1,200
equally to the performance obligations for Products A and B.
The entity recognizes revenue of $600 when Product A transfers to the customer at contract inception.
On November 30, 20X0, the scope of the contract is modified to:
Add a promise to transfer Product C (in addition to the undelivered Product B under the original contract) to the
customer on June 1, 20X1.
Increase the price of the contract by $300 (fixed consideration), which does not represent the standalone selling
price of Product C. The standalone selling price of Product C is the same as the standalone selling prices of
Products A and B.
At the date of the contract modification, the entity determines that:
The remaining Products B and C are distinct from Product A, which had transferred to the customer before the
modification.
The promised consideration for the additional Product C does not represent its standalone selling price.
The entity accounts for the contract modification as if it were the termination of the existing contract and the
creation of a new contract.
As a result, the consideration allocated to the remaining performance obligations (Products B and C) is $900, which
consists of:
The transaction price from the original contract that had been allocated to Product B — $600
The consideration promised in the modification — $300
The $900 transaction price for the modified contract is allocated equally to the performance obligations for
Products B and C based on their relative standalone selling prices. That is, $450 is allocated to each performance
obligation.
After the modification but before the delivery of Products B and C, the entity revises its estimate of the amount of
variable consideration to which it expects to be entitled to $240 (rather than the previous estimate of $200). The
entity concludes that the change in estimate of the variable consideration can be included in the transaction price
because it is probable that a significant reversal in cumulative revenue recognized will not occur when the
uncertainty is resolved.
Even though the modification was accounted for as if it were the termination of the existing contract and the
creation of a new contract, the increase in the transaction price of $40 is attributable to variable consideration
promised before the modification. Therefore, the change in the transaction price (a $40 increase) is allocated to
the performance obligations for Product A and Product B on the same basis as at contract inception (see Section 4.8
for discussion on changes in transaction price). That $40 increase in transaction price is accounted for as follows:
The entity recognizes revenue of $20 for Product A in the period in which the change in the transaction price
occurs.
REVENUE RECOGNITION UNDER ASC 606 199
Because Product B had not transferred to the customer before the contract modification, the change in the
transaction price that is attributable to Product B ($20) is allocated to the remaining performance obligations at
the time of the contract modification. This is consistent with the accounting that would have been required if
that amount of variable consideration had been estimated and included in the transaction price at the time of
the contract modification.
Therefore, the entity allocates the $20 increase in the transaction price for the modified contract equally to the
performance obligations for Products B and C. This is because the products have the same standalone selling
prices, and the variable consideration allocation exception criteria are not met (see Section 5.5 for related
discussion). Consequently, the amount of the transaction price allocated to the performance obligations for
Products B and C increases by $10 to $460 each.
On March 1, 20X1, the entity transfers Product B to the customer and recognizes revenue of $460. On June 1, 20X1,
the entity transfers Product C to the customer and recognizes revenue of $460.
EXAMPLE 7-10 (ADAPTED FROM ASC 606-10-55-125 THROUGH 55-128): MODIFICATION OF A SERVICES
CONTRACT — INTERACTION OF THE CONTRACT MODIFICATION GUIDANCE AND THE SERIES PROVISION
An entity enters a three-year contract with a customer to clean the customer’s offices weekly. The customer
promises to pay $200,000 annually. Assume that the standalone selling price of the services at contract inception is
$200,000 annually. The entity recognizes revenue of $200,000 per year during the first two years of providing
services.
At contract inception, the entity assesses that each week of cleaning service is distinct. The entity determines that
the weekly cleaning services are a series of distinct services that are substantially the same and have the same
pattern of transfer to the customer (that is, the services transfer to the customer over time and use the same
method (time-based) to measure progress). Therefore, even though each week of cleaning service is distinct, the
entity accounts for the cleaning contract as a single performance obligation. (See Chapter 3 for discussion on
identification of performance obligations including the series guidance.)
At the end of the second year, the entity and the customer modify the contract:
The fee for the third year is reduced to $160,000.
The customer agrees to extend the contract for three additional years for consideration of $400,000 payable in
three equal annual installments of $133,333 at the beginning of years 4, 5, and 6.
At the date of the modification, the entity determines:
The additional services (for years 4 through 6) are distinct.
The standalone selling price of the additional services at the date of contract modification (that is, the beginning
of the third year) is $160,000 per year. The entity’s standalone selling price at the date of contract modification,
multiplied by the additional three years of services, is $480,000, which is deemed as an appropriate estimate of
the standalone selling price of the multi-year contract.
The price for the additional years of service does not reflect the standalone selling price of the additional
services.
Therefore, the entity accounts for the modification as if it were a termination of the original contract and the
creation of a new contract with consideration of $560,000 for four years of cleaning service. The entity recognizes
revenue of $140,000 per year ($560,000 divided by four years) as the services are provided over the remaining four
years.
REVENUE RECOGNITION UNDER ASC 606 200
EXAMPLE 7-11 (ADAPTED FROM ASC 606-10-55-129 THROUGH 55-133): MODIFICATION RESULTING IN A
CUMULATIVE CATCH-UP ADJUSTMENT TO REVENUE
A construction entity enters a contract with a customer to construct a building on a piece of land owned by the
customer. The contract provides for fixed consideration of $2 million and a performance bonus of $400,000 if the
building is completed within 24 months from contract inception.
The entity determines that the contract includes a single performance obligation (to construct the building). The
entity determines that the customer controls the building during construction and therefore its performance
obligation is satisfied over time. (See Chapters 3 and 6 for identifying performance obligations and recognizing
revenue, respectively.)
At contract inception, in determining whether the bonus should be included in the transaction price, the entity
observes:
The completion of the building is highly susceptible to factors outside the entity’s influence, including weather
and regulatory approvals.
The entity has limited experience with similar types of contracts.
Based on the above analysis, the entity does not include the $400,000 bonus in the transaction price because it
cannot conclude that it is probable that a significant reversal of cumulative revenue recognized will not occur. (See
Section 4.3 for discussion on estimating variable consideration and the variable consideration constraint.)
At contract inception, the entity determines that a cost-based input measure provides an appropriate measure of
progress toward complete satisfaction of the performance obligation.
The entity expects the following at contract inception:
Transaction Price $ 2,000,000
Expected Costs 1,400,000
Expected Profit (30%) $ 600,000
By the end of the first year, the entity has satisfied 60% of its performance obligation based on costs incurred to
date ($840,000) relative to total expected costs ($1.4 million). The entity reassesses the variable consideration and
concludes that the bonus is still fully constrained. Therefore, the cumulative revenue and costs recognized for the
first year are:
Revenue $ 1,200,000
Expected Costs 840,000
Expected Profit (30%) $ 360,000
In the first quarter of the second year, the entity and the customer agree to modify the contract by changing the
floor plan of the building. As a result:
The fixed consideration and expected costs increase by $300,000 and $240,000, respectively. That is, total
potential consideration after the modification is $2.7 million ($2.3 million fixed consideration + $400,000
performance bonus).
The allowable time for achieving the $400,000 bonus is extended by 6 months to 30 months from the original
contract inception date.
At the date of the modification, the entity considers its experience and the remaining work performed (which is
primarily inside the building and not subject to weather conditions) and concludes it is probable that, including the
bonus in the transaction price will not result in a significant reversal of cumulative revenue recognized. Therefore,
the entity includes the $400,000 in the transaction price.
REVENUE RECOGNITION UNDER ASC 606 201
In assessing the appropriate accounting for the contract modification, the entity concludes that the remaining goods
and services provided under the modified contract are not distinct from the goods and services transferred on or
before the date of contract modification.
Therefore, the entity accounts for the contract modification as if it were part of the original contract:
The entity updates its measure of progress at the date of contract modification and estimates that it has
satisfied 51.2% of its performance obligation ($840,000 actual costs incurred divided by $1,640,000 total
expected costs).
The entity recognizes additional revenue of $182,400 [(51.2% complete × $2,700,000 modified transaction price)
less $1,200,000 revenue recognized to date] at the date of the modification as a cumulative catch-up
adjustment.
EXAMPLE 7-12: MODIFICATION OF A CONTRACT — APPLICATION OF A COMBINATION OF MODIFICATION
ACCOUNTING APPROACHES WHEN ONLY SOME REMAINING GOODS OR SERVICES ARE DISTINCT
A technology entity enters a contract with a customer to provide the following goods and services:
Three-year software license
Significant software customizations
One year of PCS, including maintenance and helpdesk services
At contract inception, the software customization services are expected to take four months. When customization
services are 40% completed, a rival entity releases software that has additional functionality not currently available
in the technology entity’s software. The technology entity agrees to add the new functionality as part of the
customization services at no extra cost to the customer. The technology entity expects the additional functionality
to take an additional two months to complete.
At contract inception, the technology entity determines that the contract includes two performance obligations
(see Chapter 3 for a discussion on identifying performance obligations):
Customized software
PCS
Additionally, at contract inception, the technology entity determines that:
The customized software is transferred over time to the customer because the customer controls the customized
software during customization
The PCS is transferred over time to the customer because the customer simultaneously receives and consumes its
benefit
(See Chapter 6 for a discussion of whether a performance obligation is satisfied over time.)
At the effective date of the modification, the technology entity observes that its remaining goods and services
include:
Remaining goods or services for the customized software with added functionality
PCS, which has not transferred to the customer yet and will be transferred to the customer after the software
customizations are complete
In assessing the appropriate accounting for the contract modification, the technology entity concludes that some of
the remaining goods and services provided under the modified contract are distinct from the goods and services
transferred on or before the date of contract modification while some are not.
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The customized software is in process at the effective date of the modification. The customization efforts
completed prior to the contract modification are not distinct from the customization efforts remaining after the
contract modification.
PCS is distinct from the customized software.
The technology entity accounts for the contract modification by applying a combination of the two modification
accounting approaches: (1) the termination of the existing contract and the creation of a new contract and (2) the
continuation of the existing contract, as follows:
Arrangement consideration is re-allocated between the two performance obligations based on the standalone
selling price of the customized software, updated to reflect the additional promised functionality, and the
original standalone selling price of the PCS.
Amounts allocated to the customized software are accounted for as a part of the existing contract (that is, as a
continuation of the existing contract) and a cumulative catch-up adjustment is made to reflect the new measure
of progress.
Amounts allocated to the PCS are accounted for as the termination of the existing contract and creation of a new
contract and are deferred until the software customizations are completed and the PCS service period begins.
BDO INSIGHTS — CONTRACT MODIFICATION GUIDANCE
The application of the contract modification guidance requires the application of professional judgment, based on
the facts and circumstances. The accounting outcome is based on whether the modified promises for goods or
services are distinct and whether the distinct promises are priced at their standalone selling prices.
Additionally, application of the contract modification guidance to certain contracts for which revenue is recognized
over time (for example, construction contracts and software application development contracts) may result in a
downward or upward cumulative catch-up adjustment to revenue at the date of contract modification.
Therefore, entities must carefully evaluate changes in the scope or pricing of existing customer contracts to
appropriately account for the effects of modifications on the amount and timing of revenue recognition.
7.4 CUSTOMER OPTIONS FOR ADDITIONAL GOODS OR SERVICES
Customer options to acquire additional goods or services for free or at a discount come in many forms, including:
Sales incentives
Customer award credits (or points)
Contract renewal options
Other discounts on future goods or services
7.4.1 Material Right
FASB REFERENCES
ASC 606-10-25-16A and 25-16B, ASC 606-10-25-18(j), ASC 606-10-32-29 and ASC 606-10-55-42 through 55-45
An entity may grant its customer an option that allows the customer to purchase additional goods or services as part of
or in conjunction with a contract. The option represents a promised good or service when the option provides the
customer with a material right. That is, customer options for additional goods or services may represent a performance
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obligation in Step 2 (see Chapter 3 for a discussion of performance obligations). The following guidance assists in
applying Steps 2 through 5 to customer options that represent a material right to the customer.
7.4.1.1 Identification of a Material Right (a Performance Obligation in Step 2)
Customer options for future goods or services represent a material right to the customer and hence a performance
obligation in the contract if the option provides a material right to the customer that it would not receive without
entering that contract. Therefore, a discount that is incremental to the range of discounts typically given for those
goods or services to that class of customer in that geographical area or market represents a material right. Conversely,
if the option allows the customer to acquire an additional good or service at a price that would reflect the standalone
selling price for that good or service, that option does not provide the customer with a material right even if the option
can be exercised only by entering into a previous contract.
A material right is a performance obligation identified in Step 2 of the five-step revenue recognition model and,
therefore, the subsequent steps related to allocation of transaction price and recognition of revenue must be applied.
IMMATERIALITY EXCEPTION IN IDENTIFYING THE PERFORMANCE OBLIGATIONS IS NOT AVAILABLE FOR A
MATERIAL RIGHT
An entity is not allowed to apply the immateriality exception in identifying the performance obligations in Step 2 to
a customer option that is determined to represent a material right — see Section 3.2.5 for a discussion of the
exception for immaterial promises in a contract.
TRG DISCUSSIONS — ASSESSMENT OF WHETHER AN OPTION GIVES RISE TO A MATERIAL RIGHT
In October 2014, the TRG discussed two issues from the evaluation on whether customer options to acquire
additional goods and services give rise to a material right:
Whether the evaluation should be performed only in the context of the current transaction or whether it should
factor in past and expected future transactions
Whether the evaluation should consider qualitative as well as quantitative factors
Most TRG members agreed that the evaluation should both:
Factor in past and future transactions, as well as present ones
Consider qualitative factors, such as whether the right accumulates over time as happens with loyalty points
TRG DISCUSSIONS — ASSESSMENT OF WHETHER VARIABLE QUANTITY CONSTITUTES A PURCHASE OPTION
OR VARIABLE CONSIDERATION
In November 2015, the TRG considered how an entity should determine whether a contractual right to acquire
additional goods or services represents an option to purchase additional goods and services or variable consideration
based on a variable quantity. This question might arise, for example, if a software entity grants 500 licenses to use
software for a fixed fee of $500,000, with the price for additional users being $800.
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TRG members agreed that all facts and circumstances should be considered when analyzing contracts with similar
provisions and that this analysis requires judgment. However, they concluded that the first step to distinguishing
between optional goods or services and variable consideration for promised goods or services is to identify:
The nature of the entity’s promise to the customer
The enforceable rights and obligations of the parties
With an option for additional goods or services, the customer has a present right to choose to purchase additional
distinct goods or services (or change the goods and services delivered). Prior to the customer’s exercise of that
right, the entity is not presently obligated to provide those goods or services and the customer is not obligated to
pay for those goods or services.
In contrast, in the case of variable consideration for a promised good or service, the entity and the customer
previously executed a contract that requires the entity to transfer the promised good or service and the customer
to pay for that promised good or service. The future events that trigger payment of additional consideration to the
entity occur after (or as) control of the goods or services have (or are) transferred. When a contract includes
variable consideration based on a customer’s actions, those actions do not oblige the entity to provide additional
distinct goods or services (or change the goods or services transferred), but rather, resolve the uncertainty from the
amount of variable consideration that the customer is obligated to pay.
7.4.1.2 Allocation of Transaction Price to Customer Options — Determination of Standalone Selling Price (Step 4)
When applying the general allocation model to allocate the transaction price to performance obligations on a relative
standalone selling price basis (see Section 5.2.1), an entity must estimate the standalone selling price for a material
right if the standalone selling price of the option is not directly observable. That estimate must reflect the discount
that the customer would obtain when exercising the option, adjusted for both of the following:
Any discount that the customer could receive without exercising the option
The likelihood that the option will be exercised
However, when the material right represents a renewal option, an entity may use an alternative approach to allocate
the consideration. See Section 7.4.2 for a discussion of renewal options.
7.4.1.3 Revenue Recognition for a Material Right (Step 5)
If an option provides a material right to the customer, the customer in effect pays the entity in advance for future goods
or services. Therefore, the entity must recognize the related revenue when either of the following is applicable:
Those future goods or services are transferred
The option expires
If an option does not provide a material right to the customer, the entity has made a marketing offer which is
accounted for in accordance with ASC 606 only when the customer exercises the option to purchase the additional
goods or services.
EXAMPLE 7-13 (ADAPTED FROM ASC 606-10-55-134 AND 55-135): OPTION THAT PROVIDES THE CUSTOMER WITH
A MATERIAL RIGHT — DISCOUNT VOUCHER
A retail entity enters a contract with a customer for the sale of a shirt for $100. As part of the contract, the entity
gives the customer a 40% discount voucher for any future purchases up to $100 in the next 30 days. As part of a
seasonal promotion, the entity intends to offer a 10% discount on all sales during the next 30 days. The 10% seasonal
discount cannot be used in addition to the 40% discount voucher.
Because all customers will receive a 10% discount on purchases during the next 30 days, the only discount that
provides the customer with a material right is the discount that is incremental to that 10% (that is, the additional
30% discount). The entity accounts for the promise to provide the incremental discount as a performance obligation
in the contract for the sale of apparel.
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To estimate the standalone selling price of the discount voucher, the entity estimates that:
There is an 80% likelihood that a customer will redeem the voucher.
A customer, on average, will purchase $50 of additional products.
Based on the above, the entity’s estimated standalone selling price of the discount voucher is $12 ($50 average
purchase price of additional products × 30% incremental discount × 80% likelihood of exercising the option).
Based on the relative standalone selling prices of the shirt and the discount voucher, the entity allocated the $100
transaction price are as follows:
Performance Obligation Standalone Selling Price
Shirt $ 100
Discount voucher 12
Total $ 112
Performance Obligation Allocated Transaction Price
Shirt $ 89 Calculated as $100 * ($100/$112)
Discount voucher 11 Calculated as $12 * ($12/$112)
Total $ 100
The entity allocates $89 to the shirt and recognizes revenue when control of the shirt transfers to the customer.
The entity allocates $11 to the discount voucher and recognizes revenue for the voucher when the customer
redeems it for goods or services or when it expires.
EXAMPLE 7-14 (ADAPTED FROM ASC 606-10-55-134 AND 55-135): OPTION THAT DOES NOT PROVIDE THE
CUSTOMER WITH A MATERIAL RIGHT — ADDITIONAL GOODS OR SERVICES
An entity in the telecommunications industry enters a contract with a customer to provide a handset and monthly
network service for three years. The network service includes up to 1,500 call minutes and 2,000 text messages
each month for a fixed monthly fee. The customer may choose to purchase additional call minutes or texts in any
month at contractually specified prices that are equal to their standalone selling prices.
The entity determines that the promises to provide the handset and network service are each separate performance
obligations because:
The customer can benefit from the handset and network service either on their own or with other resources that
are readily available to the customer
The handset and network service are separately identifiable
(See Chapter 3 for a discussion of performance obligations.)
In analyzing the customer’s option to purchase additional call minutes or texts, the entity observes that the prices
of the additional call minutes and texts reflect the standalone selling prices for those services. Therefore, the
entity concludes that the option to purchase the additional call minutes and texts does not provide a material right
that the customer would not receive without entering into the contract. Rather, the entity has made a marketing
offer that is accounted for in accordance with ASC 606 only when the customer exercises the option.
Because the option for additional call minutes and texts does not grant the customer a material right, the entity
concludes it is not a performance obligation in the contract. Therefore, the entity does not allocate any of the
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transaction price to the option for additional call minutes or texts. The entity will recognize revenue for the
additional call minutes or texts if and when the entity provides those services.
EXAMPLE 7-15 (ADAPTED FROM ASC 606-10-55-353 THROUGH 55-356): CUSTOMER LOYALTY PROGRAM
A retail entity has a customer loyalty program that rewards a customer with one customer loyalty point for every
$10 of purchases. Each point is redeemable for a $1 discount on any future purchases of the entity’s products.
During a reporting period, customers purchase products for $100,000 and earn 10,000 points that are redeemable
for future purchases. The consideration is fixed, and the standalone selling price of the purchased products is
$100,000.
The loyalty points provide a material right to customers that they would not receive without entering a contract.
Therefore, the entity concludes that the promise to provide loyalty points to the customer is a performance
obligation.
Based on the historical data and other relevant evidence, the entity estimates that 9,500 points are expected to be
redeemed. Based on the likelihood of redemption, the entity estimates a standalone selling price of $0.95 per
loyalty point, for a total value of points earned during the period equaling $9,500.
The entity allocates the transaction price, $100,000, to the product and the loyalty points on a relative standalone
selling price basis as follows:
Product $ 91,324 Calculated as $100,000 x ($100,000/$109,500)
Points $ 8,676 Calculated as $9,500 x ($9,500/$109,500)
At the end of the first reporting period, 4,500 points have been redeemed, and the entity continues to expect 9,500
points to be redeemed in total. The entity recognizes the following related to the loyalty points at the end of the
first reporting period:
Revenue of $4,110 [(4,500 points ÷ 9,500 points) × $8,676]
A contract liability of $4,566 ($8,676 – $ 4,110) for the unredeemed points
At the end of the second reporting period, 8,500 points have been redeemed cumulatively. The entity updates its
estimate of the points that will be redeemed and now expects that 9,700 points will be redeemed. The entity
recognizes revenue for the loyalty points of $3,493 {[(8,500 total points redeemed ÷ 9,700 total points expected to
be redeemed) × $8,676 initial allocation]– $4,110 recognized in the first reporting period}. The contract liability
balance remaining at the end of the second reporting period is $1,073 ($8,676 initial allocation – $7,603 of
cumulative revenue recognized).
BDO INSIGHTS — CUSTOMER LOYALTY ARRANGEMENTS AND PRINCIPAL VERSUS AGENT CONSIDERATIONS
The accounting illustrated in Example 7-15 in this chapter may not apply to all customer loyalty arrangements
because the terms and conditions may differ. Especially when there are more than two parties to the arrangement,
an entity must consider all facts and circumstances to determine the customer in the transaction that gives rise to
the award credits. For example, a bank may issue loyalty points to a credit card customer, which can be redeemed
by the customer at a third-party entity such as an airline, hotel, or restaurant. An entity must consider principal
versus agent considerations to appropriately account for three-party revenue transactions — see Section 7.2 for a
related discussion. Accounting for customer loyalty programs requires the application of professional judgment,
based on facts and circumstances.
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7.4.2 Renewal Options
FASB REFERENCES
ASC 606-10-55-45
A renewal option is different from customer loyalty programs, discount vouchers, and many other discounts on future
goods or service. With loyalty programs and vouchers, the underlying goods or services in the contract with the
customer often has a different nature rather than being similar to the original goods or services in the original
contract. A renewal option, in contrast, gives a customer the right to acquire additional goods or services of the same
type as those supplied under an existing contract. Because of that difference, an entity may elect a practical
alternative to estimate the standalone selling price of a renewal option that constitutes a material right.
PRACTICAL ALTERNATIVE TO ESTIMATE THE STANDALONE SELLING PRICE OF A RENEWAL OPTION THAT
CONSTITUTES A MATERIAL RIGHT
Instead of estimating the standalone selling price of the renewal option directly, an entity can elect a practical
alternative to allocate the transaction price to the optional goods or services by reference to the goods or services
expected to be provided and the corresponding expected consideration if both of the following conditions are met:
The additional goods or services are similar to the original goods or services in the contract (that is, an entity
continues to provide additional goods or services that are similar to what it was already providing). As a result, it
may be more intuitive to view the goods or services underlying such options as part of the initial contract.
The additional goods or services are provided in accordance with the terms of the original contract. As a result,
the pricing of the additional goods or services cannot be changed beyond the parameters specified in the original
contract.
In essence, this alternative approach allows an entity to treat the material right as if the optional goods or services
were additional promises in the contract, and the consideration to be received when the option is exercised as
additional consideration.
BC393 of ASU 2014-09 states that the practical alternative requires an entity to include the optional goods or services
that it expects to provide and the corresponding consideration that it expects to receive in the initial measurement of
the transaction price. The FASB reasoned that it would be simpler for an entity to view a contract with renewal options
as a contract for its expected term (that is, including the expected renewal periods) rather than as a contract with a
series of renewal options.
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EXAMPLE 7-16 (ADAPTED FROM ASC 606-10-55-343 THROUGH 55-352): OPTION THAT PROVIDES THE CUSTOMER
WITH A MATERIAL RIGHT ― RENEWAL OPTION
An entity enters 100 separate contracts with customers to provide one year of maintenance services for $10,000 per
contract. The following are the key terms:
At the end of the year, each customer has the contractual right (or option) to renew the maintenance contract
for a second year by paying an additional $10,000.
Customers who renew for a second year are granted the option to renew for a third year for $10,000.
If customers do not sign up for the maintenance services initially (when the products are new) or allow the
services to lapse, the entity charges significantly higher prices for annual maintenance services:
• $30,000 in Year 2
• $50,000 in Year 3
The entity evaluates the customer’s renewal option for maintenance services in Step 2 and determines that:
The renewal option provides a material right to the customer that it would not receive without entering the
contract because the price for maintenance services is significantly higher if the customer elects to purchase the
services only in Year 2 or 3.
Part of each customer’s payment of $10,000 in Year 1 is, in effect, a nonrefundable prepayment of the services
provided in a subsequent year.
Based on the above analysis, the entity concludes that the promise to provide the renewal option is a performance
obligation.
The entity then observes that:
The renewal option is for a continuation of maintenance services
Those services are provided in accordance with the terms of the existing contract
In accordance with the practical alternative for estimating the standalone selling price of a renewal option, the
entity allocates the transaction price by determining the consideration that it expects to receive in exchange for all
the services that it expects to provide under the renewal options (instead of determining the standalone selling
prices for the renewal options directly).
At contract inception, the entity estimates that:
90 customers are expected to renew at the end of Year 1 (90% of contracts sold).
81 customers are expected to renew at the end of Year 2 (90% of the 90 customers that renewed at the end of
Year 1 will also renew at the end of Year 2, that is, 81% of contracts sold).
Based on the above estimates, the entity determines that, at contract inception, the expected consideration for
each contract is $27,100 [$10,000 + (90%× $10,000) + (81% × $10,000)].
The entity also determines that recognizing revenue based on costs incurred relative to the total expected costs
depicts the transfer of services to the customer. Estimated costs for a three-year contract are as follows:
Year 1 $ 6,000
Year 2 7,500
Year 3 10,000
Accordingly, the pattern of revenue recognition expected at contract inception for each contract is as follows:
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Expected Costs Adjusted for Likelihood of
Contract Renewal
Allocation of Consideration Expected
Year 1 $ 6,000 ($6,000 x 100%) $ 7,799 [($6,000/$20,850) x $27,100]
Year 2 6,750 ($7,500 x 90%) 8,773 [($6,750/$20,850) x $27,100]
Year 3 8,100 ($10,000 x 81%) 10,528 [($8,100/$20,850) x $27,100]
Total $ 20,850
$ 27,100
Therefore, at contract inception, the entity allocates $220,100 of the consideration received to date [cash of
$1,000,000 – revenue to be recognized in Year 1 of $779,900 ($7,799 × 100)] to the option to renew at the end of
Year 1.
Assuming there is no change in the entity’s expectations and the 90 customers renew as expected, at the end of the
Year 1, the entity has collected cash of $1,900,000 [(100× $10,000) + (90 × $10,000)], has recognized revenue of
$779,900 ($7,799 × 100), and has recognized a contract liability of $1,120,100.
Consequently, upon renewal at the end of Year 1, the entity allocates $242,800 to the option to renew at the end of
Year 2 [cumulative cash of $1,900,000– cumulative revenue recognized in Year 1 and to be recognized in Year 2 of
$1,657,000 ($780,000 + $8,770 × 100)].
If the actual number of contract renewals was different than what the entity expected, the entity would update the
transaction price and the revenue recognized accordingly.
EXAMPLE 7-17: GYMNASIUM MEMBERSHIP — RENEWAL OPTION
An entity operates gymnasiums for its members. To become a member, a customer must pay a one-time upfront
joining fee of $1,000 and an annual membership fee. At the end of each year, the customer has a right to renew the
membership by paying the annual membership fee.
At contract inception, the entity assesses whether the upfront joining fee relates to the transfer of a promised good
or service and concludes that it does not. Rather, the joining fee represents an advance payment for future gym
services.
To determine whether the upfront fee should be recognized over the contract period (for example, one year) or
based on expected renewal behavior (for example, potentially longer than one year), the entity must assess
whether the renewal option provides a material right to the customer.
The entity observes that:
The upfront joining fee, in effect, entitles the customer to renew the contract by paying the annual membership
fee and avoiding the upfront joining fee in subsequent years.
Because a member is not required to pay the upfront fee in renewal periods, the upfront fee essentially results
in a discounted fee for subsequent membership periods when compared to the fee payable upon signing a new
membership.
Based on the above observations, the entity concludes that the renewal option (that is, the customer’s option to
continue to purchase gymnasium services beyond Year 1) provides a material right to the customer and therefore is
a separate performance obligation.
The entity estimates the number of renewal options the customers are expected to exercise and allocates the
upfront fee plus the total annual fees for the current term and each expected renewal period to the current term
and the expected renewal periods. Practically, this may result in:
Straight-line recognition of the upfront fee over the expected membership term
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Recognition of each annual membership fee over the annual period to which it relates
TRG DISCUSSIONS — ACCOUNTING FOR A CUSTOMER’S EXERCISE OF A MATERIAL RIGHT — CONTINUATION
OF A CONTRACT OR CONTRACT MODIFICATION
ASC 606 does not provide explicit guidance on the accounting model to apply when an option that is a material right
is exercised by the customer. The question that arises is whether it should be considered:
A continuation of the original contract whereby the additional consideration would be allocated to the material
right
A contract modification, which could require consideration to be re-allocated between performance obligations
Variable consideration
In March 2015, TRG members agreed that the exercise of a material right should be viewed as a continuation of the
contract but also acknowledged the FASB staff’s view that it would be reasonable for an entity to account for it as
either a continuation of the contract or a contract modification. The possibility of treating the amount allocated to
the material right as variable consideration was rejected.
Additionally, TRG members observed that in most, but not all, cases the outcome of applying either acceptable
approach would be similar. Only in cases in which the optional goods or services are determined to be not distinct
from the original promised goods or services would the results appear to differ, because the application of the
contract modification guidance may result in a cumulative catch-up adjustment to the revenue recognized (see
Section 7.3 for a related discussion). However, the FASB staff observed that an entity typically would conclude that
an optional good or service is distinct.
BDO INSIGHTS — ACCOUNTING POLICY ELECTION TO ACCOUNT FOR A CUSTOMER’S EXERCISE OF A MATERIAL
RIGHT
Based on the TRG discussions on accounting for a customer’s exercise of a material right as either a continuation of
a contract or a contract modification, an entity needs to make an accounting policy election regarding the approach
it uses to account for the exercise of material right. Determining the appropriate method to account for a
customer’s exercise of a material right requires the application of judgment. An entity must consistently apply the
method elected to similar types of material rights with similar facts and circumstances.
EXAMPLE 7-18: RENEWAL OPTION — SPORTS SEASON TICKETS
An entity, a professional football club, regularly offers season tickets for the following season (Season 1) at a price
of $5,000. However, as part of a promotion drive, it offers customers the opportunity to buy a season ticket for the
following season (Season 1) for $8,000, which will also grant those customers the right to a 25% discount off the
standard season ticket price for the subsequent 4 seasons (Seasons 2-5).
At contract inception, the entity makes the following estimates:
The price of annual season tickets in future years is expected to remain at $5,000.
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All customers that purchase a Season 1 ticket for $8,000 are expected to exercise the option to purchase season
tickets at a discount in Seasons 2-5 (that is, a 100% renewal rate is expected).
The entity determines that the practical alternative for estimating the standalone selling price of a renewal option
is applicable because the services provided in Seasons 2-5:
Are similar to the services provided in Season 1.
Will be provided in accordance with the terms of the existing contract. The entity does not have a contractual
right to change or withdraw the 25% discount offer.
Under the practical alternative election, the total transaction price is allocated to all of the season tickets that are
expected to sell over the five-year period (that is, Seasons 1-5). In effect, the contract is viewed as a single
contract for its expected term of five years (not a one-year contract with a series of renewal options) because all
renewal options are expected to be exercised.
As a result, the total consideration receivable ($8,000 in Season 1 plus $3,750 for each of Seasons 2-5) is recognized
evenly over the five-year period, resulting in revenue of $4,600 (($8,000 + ($5,000 * 4 * 0.75))/5) being recognized
in each year.
For simplicity, no adjustment has been made for any potential financing component.
For each Season 1 ticket sold for $8,000, it would not be appropriate for the entity to recognize $5,000 during
Season 1 and allocate $3,000 to customer renewal options for Seasons 2-5 (rather than allocating $8,000 to all five
seasons based on relative standalone selling prices). That approach would result in separate contracts being
accounted for in the initial and subsequent periods instead of a single overall contract for a five-year period. The
allocation of $3,000 to Seasons 2-5 would also be similar to the use of a residual approach for the allocation of the
transaction price to the renewal options, which would also be inappropriate.
TRG DISCUSSIONS — ANALYZING CUSTOMER LIFE TO DETERMINE WHETHER A NONREFUNDABLE UPFRONT
FEE PROVIDES A MATERIAL RIGHT TO THE CUSTOMER
In March 2015, the TRG discussed whether a one-time nonrefundable upfront fee (for example, an initial fee for
health club membership or an activation fee telecommunication services) provides the customer with a material
right. At that meeting, the TRG members stated that an entity’s average customer life might indicate whether an
upfront fee provides the customer with a material right. For example, a customer life that extends beyond a one-
month contractual period may indicate the upfront fee incentivizes the customer to continue purchasing a health
club membership or telecommunication services because the customer will not be charged an additional initial or
activation fee in subsequent months, as opposed to incurring a similar upfront fee with a new entity.
BDO INSIGHTS — ANALYZING CUSTOMER LIFE TO DETERMINE THE EXISTENCE OF A MATERIAL RIGHT
In the context of the TRG discussions on analyzing customer life to determine whether a nonrefundable upfront fee
provides a material right to the customer, customer life depends on both parties desiring to continue the
relationship. For instance, gym memberships and telecommunication services are often provided on a month-to-
month basis. In practice, there is no requirement for entities to guarantee the availability of monthly services, such
that customers are the only parties with renewal rights. In such scenarios, the entities typically reserve the right to
discontinue services in their terms and conditions. However, we believe a material right may nonetheless exist
based on the reasonable expectation of additional purchases, as opposed to only those situations in which the
customer obtains an enforceable right to additional purchases after the initial term. We believe this is consistent
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with the discussion in BC87 of ASU 2014-09, which states that promises in the contract do not need to be
enforceable by law but are rather identified based on a customer’s expectations. If the customer has a valid
expectation that the entity will transfer a good or service, then the customer would view those promises as part of
the negotiated exchange.
Analyzing the accounting for upfront fees and determining the average customer life require the application of
professional judgment, based on the facts and circumstances.
7.4.3 Early Renewal Rights
Entities often offer noncancellable contracts that provide the customer with the option to renew the contract prior to
contract expiry. For example, this practice is common in the telecommunications industry and other industries where a
product is sold at the inception of the contract with ongoing services provided over the contract period.
EXAMPLE 7-19: EARLY RENEWAL RIGHT — TELECOMMUNICATION DEVICE AND SERVICES
An entity in the telecommunications industry contracts with customers to sell a device and a package of services.
Following are the key terms:
The contract has a 24-month noncancellable term.
Customer must pay 24 equal monthly installments. The entity allocates each installment between the device and
the services on the same basis.
The contract states that the customer has the option to renew the contract at any time after 21 months without
penalty. No recovery is made for installments that would have been made during the period from renewal up to
the end of the original 24-month contract period.
The early renewal results in the customer obtaining a new device and the same services for a subsequent 24
months from the renewal date.
The renewed contract is priced at the standalone selling price for that contract when the customer exercises the
early renewal right.
The entity needs to determine the appropriate accounting for the customer’s option to renew early (that is, prior to
the end of the full 24-month contract term).
The entity observes that the early renewal right was embedded in the enforceable rights and obligations agreed to
by the parties at contract inception. Therefore, the early renewal option is not a contract modification because it is
not an amendment to the original rights and obligations of the parties. ASC 606 provides that a “contract
modification exists when the parties to the contract approve a modification that either creates new or changes
existing enforceable rights and obligations of the parties to the contract.”
The entity observes that the option to renew early affects the amount of consideration to which the entity expects
to be entitled for the device provided to the customer at contract inception the amount of consideration could vary
depending on when customers exercise their option to renew. Further, because customers renew at the standalone
selling price, there is no material right present. Consequently, the amount of consideration allocated to the device
is considered variable.
The entity must therefore estimate the amount of variable consideration to which it will be entitled, subject to the
constraint on variable consideration. As a result, variable consideration (that is, the monthly installments between
months 21 and 24) will only be recognized as revenue to the extent that it is probable that there will not be a
significant reversal of cumulative revenue recognized when the uncertainty over the variable consideration is
resolved. (See Section 4.3 for a discussion of variable consideration.)
In this case, the uncertainty will be resolved when it is known whether the customers will exercise their early
renewal rights which will affect the allocation of monthly installments between:
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The handset, for which revenue will be recognized upon transfer of control to the customer, generally at
contract inception, with a related receivable being settled through the partial allocation of future monthly
installments (see Chapter 8 for discussion on accounting for receivables)
The services, for which revenue will be recognized over the period of the contract
The amount of variable consideration that is expected to be received will depend on the facts and circumstances in
each case. However, to consider a period of more than 21 months for part or all of the customer base, clear
evidence would be required of the expected pattern of exercise of the early renewal option.
7.4.4 Customers’ Unexercised Rights — Breakage
FASB REFERENCES
ASC 606-10-45-2, ASC 606-10-55-46 through 55-49
A customer’s nonrefundable prepayment to an entity gives the customer a right to receive a good or service in the
future and obliges the entity to stand ready to transfer a good or service. Upon receipt of a prepayment from a
customer, an entity must recognize a contract liability in the amount of the prepayment for its performance obligation
to transfer, or to stand ready to transfer, goods or services in the future (see Chapter 8 for additional discussion on
contract liability).
An entity must derecognize that contract liability and recognize revenue when it transfers those goods or services and
therefore satisfies its performance obligation. However, customers may not always exercise all their contractual rights.
Those unexercised rights are often referred to as breakage. Common examples include:
Forfeiting balances on gift cards
Not claiming loyalty points or air miles
Nonrefundable theatre and travel tickets, where the customer foregoes amounts paid in advance if they do not
attend the event
Declining to exercise a renewal option that is accounted for as a material right
Depending on whether an entity expects to be entitled to a breakage amount, it accounts for any resulting breakage as
follows:
If an entity expects to be entitled to a breakage amount in a contract liability, it recognizes the expected breakage
amount as revenue in proportion to the pattern of rights exercised by the customer.
If an entity does not expect to be entitled to a breakage amount, it recognizes the expected breakage amount as
revenue when the likelihood of the customer exercising its remaining rights becomes remote.
CONSIDER VARIABLE CONSIDERATION CONSTRAINT TO DETERMINE BREAKAGE
To determine whether an entity expects to be entitled to a breakage amount, an entity must consider the guidance
in Section 4.3 on constraining estimates of variable consideration. Specifically, an entity must only recognize
breakage revenue to the extent that it is probable that there will not be a significant reversal of cumulative
revenue recognized when the uncertainty related to the breakage is subsequently resolved.
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An entity must not recognize breakage revenue for any consideration received that must be remitted to another party,
for example, a government entity in accordance with applicable unclaimed property laws. Instead, the entity should
continue to report the amounts as a liability, albeit due to the relevant third party, rather than as a contract liability
or deferred revenue.
BDO INSIGHTS — ACCOUNTING FOR BREAKAGE LIABILITIES MAY REQUIRE LEGAL ANALYSIS
Determining whether breakage liabilities are subject to unclaimed property laws is a legal question and may require
judgment as the laws often vary by state. As a result, an entity could have multiple breakage liabilities that are
accounted for differently. As such, entities may need to discuss their fact patterns with unclaimed property
specialists. Accounting for breakage liabilities requires the application of professional judgment, based on the facts
and circumstances.
Separately, this guidance does not address the accounting for dormancy or other fees charged to holders of unused
stored-value products.
EXAMPLE 7-20: OPTION THAT PROVIDES THE CUSTOMER WITH A MATERIAL RIGHT — BREAKAGE
(Continued from Example 7-18)
An entity sells 10,000 season tickets for $8,000 each that grant customers the right to a 25% discount in each of the
subsequent seasons 2-5. At the start of Season 1, the entity has therefore received $80 million of which $46 million
is recognized as revenue in Season 1 and $34 million relates to customers’ renewal options.
The two extremes of potential outcomes are:
If no customer exercises its renewal option, $80 million would be received for Season 1
If every customer exercises its renewal options for all of Seasons 2-5, then $8.5 million will be recognized as
revenue in each of Seasons 2-5 (that is, $34 million or $850 per season ticket holder per season)
The contractual terms of the renewal option stipulate that if a customer fails to renew a season ticket in any year,
it loses its right to the 25% discount in all subsequent seasons. For example, if a season ticket holder renews at a
25% discount in Season 2 but does not renew its season ticket in Season 3, it would lose its right to a 25% discount in
Seasons 4 and 5.
At the start of Season 2:
The price of a standard season ticket rises to $5,500.
800 customers do not exercise their renewal option and, hence, forfeit rights to a 25% discount in Seasons 3-5.
9,200 customers renew their season ticket at a price of $4,125, calculated as the standard price of $5,500 less
the 25% discount.
The entity has no prior experience offering such discounts to customers and therefore cannot rely on historical
experience to estimate whether it will be entitled to any breakage. However, it considers that the customers paid a
premium for the current season tickets to obtain the future discount, indicating that most expect to exercise their
renewal rights. Consequently, it concludes that it cannot recognize any of the $34 million as breakage revenue prior
to knowing that customers have forfeited their option (that is, by not renewing their season ticket) as to do
otherwise could result in a significant reversal of revenue in future periods of the amount of breakage recognized.
Therefore, the entity does not recognize any revenue in Season 1 for breakage.
At the start of Season 2, the entity recognizes $2.72 million as breakage (that is, $850 x 800 x 4). This recognition
reflects that 800 customers have forfeited their renewal rights (valued at $850 per season for each of Seasons 2-5)
and is therefore accounted for as additional revenue earned for services provided in Season 1. The entity also
recognizes:
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$7.82 million during Season 2 (that is, $850 x 9,200) reflecting that 9,200 customers exercised their renewal right
for Season 2
$37.95 million during Season 2 (that is, $4,125 x 9,200) reflecting the amounts paid by those 9,200 customers for
the price paid for the Season 2 ticket
BDO INSIGHTS — PERPETUAL CUSTOMER OPTIONS
In some cases, customer options are perpetual and do not have expiration dates (for example, air miles often have
no expiry date). Some have questioned whether an entity applies the guidance on unexercised rights (or breakage)
in those cases. We believe the guidance on constraining estimates of variable consideration applies to all customer
options, such as breakage liabilities, including those that are perpetual.
The guidance on a customer option that is a material right requires an entity to estimate the standalone selling price of
the option at contract inception. In determining the standalone selling price of the option, an entity must consider the
likelihood that the option will be exercised. Additionally, an entity must recognize any change in the likelihood that
the option will be exercised when estimating the measure of progress of the performance obligation related to the
option.
In other words, the standalone selling price of the option is not updated after contract inception. Rather, the entity
updates its estimate of the portion of the option that will be redeemed. This results in the entity recognizing revenue
in proportion to the pattern or recognition of other performance obligations in the contract.
Once the number of options expected to be exercised have actually been exercised, the entity no longer recognizes a
contract liability for the options.
In situations where a single option exists and the portfolio approach is not or cannot be applied, the standalone selling
price of the option would still include the likelihood that the option will be exercised. The revenue related to the
option would be recognized when the option is exercised or when it is determined that the likelihood of the option
being exercised becomes remote.
BDO INSIGHTS — TRACKING DATA TO ACCOUNT FOR BREAKAGE REVENUE COULD BE CHALLENGING
The model for recognizing breakage revenue can be challenging to apply in practice. For example, to recognize
breakage “in proportion to the pattern of rights expected to be exercised” related to gift cards that are expected
to expire unused, an entity must track gift card redemptions based on when the cards were sold. Entities should
proactively work with any third-party program managers to make sure the manager will be able to provide adequate
tracking and related reporting to support the entity’s recognition of breakage.
7.5 LICENSING
FASB REFERENCES
ASC 606-10-55-54 through 55-65B
The promised good or service in a contract may include granting a license that establishes a customer’s rights over the
IP of an entity. Licenses of IP may include, but are not limited to, licenses of:
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Software (other than software subject to a hosting arrangement
13
that does not meet the criteria in ASC 985-20-
15-5,
14
commonly referred to as SaaS arrangement)
Other technology, such as drug compounds or technical designs
Media and entertainment (for example, motion pictures, music, podcasts)
Franchises
Patents, trademarks, and copyrights
Given the unique nature of a license, ASC 606 includes implementation guidance in to assist with the application of the
five-step revenue recognition model to licenses.
7.5.1 Identification of Performance Obligations in a Contract That Includes a License (Step 2)
An entity may explicitly or implicitly promise to transfer other goods or services to the customer in addition to a
promise to grant a license. When a contract with a customer includes a promise to grant a license (or licenses) in
addition to other promised goods or services, an entity applies the guidance to identify each distinct promised good or
service (that is, a performance obligation) in the contract, consistent with the requirement in Step 2 for any other
contracts with customers that include multiple promises. See Chapter 3 for discussion on determining whether a
promised good or service is distinct.
If the promise to grant a license is not distinct from other promised goods or services in the contract, an entity must
account for the promise to grant a license and those other promised goods or services together as a single performance
obligation.
Following are examples of licenses that are not distinct from other goods or services promised in the contract:
A license that forms a component of a tangible good and is integral to the functionality of the good
A license that the customer can benefit from only in conjunction with a related service, for example, an online
service provided by the entity that enables, by granting a license, the customer to access content
When a single performance obligation includes a license (or licenses) of IP and one or more other goods or services, an
entity considers the nature of the combined good or service for which the customer has contracted in:
Determining whether that combined good or service is satisfied over time or at a point in time (see Section 7.5.2
and Chapter 6 for a discussion of satisfaction of performance obligations)
Selecting an appropriate method for measuring progress if the combined good or service is satisfied over time (see
Section 6.4 for a discussion of measure of progress)
In considering the nature of the combined good or service for which the customer has contracted, an entity must also
consider whether the license that is part of the single performance obligation provides the customer with a right to use
or a right to access IP.
7.5.2 Nature of License — Right to Access Versus Right to Use
To evaluate whether a license of IP transfers to a customer at a point in time or over time and hence whether revenue
for the license is recognized at a point in time or over time, an entity must consider whether the nature of the entity’s
promise in granting the license to the customer is to provide the customer with a right to access or a right to use. The
following diagram summarizes the guidance related to determining whether the nature of the IP right granted to a
13
ASC 985-20 defines a hosting arrangement as “[i]n connection with accessing and using software products, an arrangement in
which the customer of the software does not currently have possession of the software; rather, the customer accesses and uses the
software on an as-needed basis.”
14
The two criteria in ASC 985-20-15-5 are:
The customer has the contractual right to take possession of a software subject to a hosting arrangement at any time during the
hosting period without significant penalty.
It is feasible for the customer to either run the software on its own hardware or contract with another party unrelated to the
vendor to host the software.
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customer is a right to access or a right of use and its effect on the timing and pattern of revenue recognition for the IP
license.
Right to Access
A right to access the entity’s IP
throughout the license period (or its
remaining economic life, if shorter).
Right to Use
A right to use the entity’s IP as it
exists at the point in time at which
the license is granted.
An entity’s promise to provide a
customer with a right to access the
entity’s IP is a performance
obligation satisfied over time
because the customer will
simultaneously receive and
consume the benefit from the
entity’s performance of providing
access to its IP as the performance
occurs (see Section 6.3).
An entity selects a method to
measure progress towards complete
satisfaction of that performance
obligation (see Section 6.4)
.
Conversely, an entity’s promise to
provide a customer with the right
to use its IP is satisfied at a point
in time.
An entity determines the point in
time at which the license transfers
to the customer (see Section 6.5).
Nature of the
rights granted
to a customer
Step 5
Considerations
for Timing and
Pattern of
Revenue
Recognition
Revenue from a license of IP cannot be recognized before both:
An entity provides (or makes available) a copy of the IP to the customer.
The beginning of the period during which the customer can use and
benefit from its right to access or its right to use the IP. That is, an entity
would not recognize revenue before the beginning of the license period
even if the entity provides (or makes available) a copy of the IP before the
start of the license period or the customer has a copy of the IP from
another transaction.
For example, an entity recognizes revenue from a license renewal no earlier
than the beginning of the renewal period.
Functional IP and Symbolic IP
To further assist entities in evaluating the nature of an IP, the standard
defines an IP as either a functional or symbolic IP. See the following flowchart
and discussion for more details.
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The following diagram depicts the decision process in evaluating whether a license of IP is a license of functional IP or
symbolic IP, and in determining whether the nature of an entity's promise in granting that license is to provide the
customer with a right to access or a right to use the entity's IP. A discussion of functional and symbolic IP and related
revenue recognition considerations follows the diagram.
Is the customer
contractually or
practically required to
use the updated IP?
Consider the nature of the IP to which the customer will have rights.
Does the IP to which the customer has rights have significant standalone functionality?
Customer has rights to a symbolic IP.
Nature of the IP is a right to access.
Revenue is recognized over time.
Customer has rights to a functional IP.
Further analysis is required for revenue recognition.
Is the functionality of the
functional IP expected to
substantively change during the
license period because of the
entity’s activities that do not
transfer a good or service to the
customer?
Nature of the functional IP is a
right to use.
Revenue is recognized at a
point in time.
Functional IP
Functional IP has significant standalone
functionality, for example, the ability to process a
transaction, perform a function or task, or be
played or aired. It derives a substantial portion of
its utility (that is, its ability to provide benefit or
value) from its significant standalone functionality.
Examples: a drug compound, technology or software
product, broadcasting rights for a movie.
Symbolic IP
Symbolic IP lacks significant standalone
functionality.
Therefore, substantially all of the utility of a
symbolic IP is derived from its association with the
entity’s past or ongoing activities.
Examples: use of a brand names or logos.
No
Yes
Yes
Nature of the
functional IP is a right
to access.
Revenue is recognized
over time.
Yes
No
No
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7.5.2.1 Symbolic IP
A customer’s ability to derive benefit from a license to symbolic IP depends on the entity continuing to support or
maintain the IP. Therefore, a license to symbolic IP grants the customer a right to access the entity’s IP, which is
satisfied over time as the entity fulfills its promise to both:
Grant the customer rights to use and benefit from the entity’s IP.
Support or maintain the IP. An entity generally supports or maintains symbolic IP by continuing to undertake those
activities from which the utility of the IP is derived and/or refraining from activities or other actions that would
significantly degrade the utility of the IP. For example, the activities that an entity continues to undertake to
support the utility of a franchise might include marketing and advertising to support the brand.
7.5.2.2 Functional IP
Generally, a license to functional IP grants a right to use the entity’s IP as it exists at the point in time at which the
license is granted. However, in certain instances, future changes to the underlying IP may result in the licenses being
treated differently. Specifically, a license grants a right to access the entity’s IP, which is recognized over time, if both
of the following criteria are met:
The functionality of the IP to which the customer has rights is expected to substantively change during the license
period because of activities of the entity that do not transfer a promised good or service to the customer.
Additional promised goods or services (for example, IP upgrade rights or rights to use or access additional IP) are not
considered in assessing this criterion.
The customer is contractually or practically required to use the updated IP resulting from the activities in the above
criterion.
BDO INSIGHTS — FUNCTIONAL IP THAT PROVIDES THE CUSTOMER A RIGHT TO ACCESS THE ENTITY’S IP
The standard and an SEC staff speech in 2019 include two fact patterns where the two criteria discussed in
Section 7.5.2.2 are met resulting in overtime revenue recognition for a functional IP:
Example 3-9 in Chapter 3, adapted from ASC 606, illustrates a functional IP license to an anti-virus software that
is combined with the updates to be provided on a when-and-if-available basis as a single performance obligation.
In that fact pattern, the updates make sure that the customer’s ability to benefit from the software would not
decline significantly during the license term.
An SEC staff speech in 2019 (see Section 3.3.2.4) described an arrangement in which a functional IP license for
software was combined with the updates to be provided on a when-and-if-available basis as a single performance
obligation. In that fact pattern, the software allows the customers (application developers) to build and
monetize their own application on various third-party platforms. Because the third-party platforms undergo
frequent updates, the software entity makes corresponding updates to its own software to make sure customers
can continue to build applications that are compatible with all supported third-party platforms. Without the
software updates, the customer’s ability to benefit from the software would be significantly limited over the
contract term because the customer would not be able to build applications that are compatible with the
updated third-party platforms.
We believe that additional, albeit limited, scenarios may exist where functional IP may be combined with a service
provided over time and hence, revenue from the functional IP would be recognized over time rather than at a point
in time. Significant judgment is required to analyze the nature of functional IP sold with a service(s) that would
substantively change the functionality of the IP and hence the benefit derived by the customer during the license
term.
Because functional IP has significant standalone functionality, an entity’s activities that do not substantively change
that functionality do not significantly affect the utility of the IP to which the customer has rights. Therefore, an
entity’s promise to the customer in granting a license to functional IP does not include supporting or maintaining the
IP. Any promise to support or maintain the functional IP would be a separate performance obligation. As a result, if a
license to functional IP is a separate performance obligation and does not meet both the criteria in Section 7.5.2.2, it
is satisfied at a point in time.
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Additionally, guarantees provided by an entity that it has a valid patent to IP and that it will defend that patent from
unauthorized use do not affect whether a license provides a right to access the entity’s IP or a right to use the entity’s
IP. Similarly, a promise to defend a patent right is not a promised good or service because it provides assurance to the
customer that the license transferred meets the specifications of the license promised in the contract.
EXAMPLE 7-21 (ADAPTED FROM ASC 606-10-55-362 THROUGH 55-363B): RIGHT TO USE — SOFTWARE LICENSE
An entity, a software developer, enters a contract with a customer to transfer a software license, perform an
installation service, and provide unspecified software updates and technical support for a specified period. The
software developer sells the license, installation service, and technical support separately. The installation service
includes changing the web screen for each type of user (for example, marketing, inventory management, and
information technology). The installation service is routinely performed by other competitor entities and does not
significantly modify the software. The software remains functional without the updates and the technical support.
The entity identifies four performance obligations in the contract:
The software license
Installation services
Software updates
Technical support
The entity assesses the nature of its promise to transfer the software license. The entity first concludes that the
software license is functional IP because the software has significant standalone functionality from which the
customer can derive substantial benefit regardless of the entity’s ongoing business activities.
Further, the entity considers whether the functional license represents a right to access IP and concludes the
following:
While the functionality of the underlying software is expected to change during the license period because of the
entity’s continued development efforts, the functionality of the software to which the customer has rights (that
is, the customer’s instance of the software) will change only because of the entity’s promise to provide when-
and-if available software updates. Because the entity’s promise to provide software updates represents an
additional promised service in the contract, the entity’s activities to fulfill that promised service are not
considered in evaluating the two criteria in Section 7.5.2.2.
The customer has the right to install, or not install, software updates when they are provided. Therefore, the
criterion in Section 7.5.2.2 on whether the customer is contractually or practically required to use the updated
IP would not be met even if the entity’s activities to develop and provide software updates had met the other
criterion in Section 7.5.2.2 on whether the functionality of the IP to which the customer has rights is expected to
substantively change during the license period because of activities of the entity that do not transfer a promised
good or service to the customer.
Based on the above analysis, the entity concludes that it has provided the customer with a right to use its software
as it exists when the license is granted. Accordingly, the entity accounts for the software license performance
obligation as a performance obligation satisfied at a point in time.
The entity recognizes revenue for the software license at the point in time at which the control of the license
transfers to the customer (see Sections 6.2 and 6.5 for related discussion), which cannot occur before the customer
can use and benefit from the license.
EXAMPLE 7-22 (ADAPTED FROM ASC 606-10-55-383 THROUGH 55-388): RIGHT TO ACCESS — LICENSES TO USE
IMAGES AND NAMES
An entity, a creator of comic strips, licenses the use of the images and names of its characters in three of its comic
strips to a customer for a five-year term. The customer, an operator of cruise ships, can use the entity’s characters
in various ways, for example in shows or parades, within reasonable guidelines. While there are main characters
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involved in each of the comic strips, newly created characters appear and disappear regularly, and the images of
the characters evolve over time.
The customer must pay a fixed payment of $1 million in each year of the five-year term.
In assessing the goods and services promised to the customer, the entity concludes that:
It has made no other promises to the customer other than the promise to grant a license.
The additional activities from the license do not directly transfer a good or service to the customer.
Based on the above analysis, the entity concludes that its only performance obligation is to transfer the license.
The entity assesses the nature of its promise to transfer the license. The entity determines that:
The licensed IP, that is, the character names and images, does not have standalone functionality. That is, the
names and images cannot process a transaction, perform a function or task, or be played or aired separate from
significant additional production that would, for example, use the images to create a movie or a show.
The utility of those names and images is derived from the entity’s past and ongoing activities such as producing
the weekly comic strip that includes the characters.
Based on the above analysis, the entity concludes that the nature of its promise is to grant the customer the right
to access the entity’s symbolic IP.
Because the nature of the entity’s promise in granting the license is to provide the customer with a right to access
the entity’s IP, the entity accounts for the promised license as a performance obligation satisfied over time.
The contract includes a single performance obligation, the license, so the entire consideration is allocated to the
license.
The entity considers a measure of progress that best depicts its performance in the license — see related discussion
in Section 6.4. The entity determines that a time-based method would be the most appropriate measure of progress
toward complete satisfaction of the performance obligation because the contract provides the customer with an
unlimited use of the licensed characters for a fixed term.
EXAMPLE 7-23 (ADAPTED FROM ASC 606-10-55-367 THROUGH 55-374): IDENTIFYING A DISTINCT LICENSE
A pharmaceutical entity enters a contact with a customer to:
License to the customer its patent rights to an approved drug compound for 10 years
Manufacture the drug for the customer for five years while the customer develops its own manufacturing
capability
The drug is a mature product and, therefore, there is no expectation that the entity will undertake activities to
change the drug (for example, to alter its chemical formula). There are no other promised goods or services in the
contract.
Assume that the manufacturing process used to produce the drug is highly specialized in nature, and thus no other
entity can manufacture the drug while the customer learns the manufacturing process and builds its own
manufacturing capability. Therefore, the license cannot be purchased separately from the manufacturing service.
Based on the above analysis, the entity determines that the customer cannot benefit from the license without the
manufacturing service. Therefore, the promises are not capable of being distinct and the license and manufacturing
service are not distinct (see Sections 3.2 and 3.3). The entity accounts for the license and manufacturing service as
a single performance obligation.
During the first five years, the customer benefits from the license only because of having access to a supply of the
drug. Therefore, the nature of the combined good or service for which the customer contracted is a sole sourced
supply of the drug for the first five years.
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After the first five years, the customer retains solely the right to use the entity’s functional IP (see Example 7-24 in
this chapter), and no further performance (such as, manufacturing the drugs) is required of the entity during
Years 6–10. The entity’s performance under the contract will be complete at the end of Year 5.
EXAMPLE 7-24 (ADAPTED FROM ASC 606-10-55-367 THROUGH 55-374): IDENTIFYING A DISTINCT LICENSE
Assume in Example 7-23 that the manufacturing process used to produce the drug is not unique or specialized and
several other entities also can manufacture the drug for the customer.
The entity assesses whether the promised goods and services (the license and the manufacturing service) are
distinct (see Chapter 3 for related discussion) as follows:
Because there are other entities that can provide the manufacturing service, the customer can benefit from the
license together with readily available resources other than the entity’s manufacturing service and can benefit
from the manufacturing service together with the license transferred to it at the start of the contract.
Therefore, the promises are capable of being distinct.
The entity concludes that its promises to grant the license and provide the manufacturing service are separately
identifiable. In concluding that the license and the manufacturing service are not inputs to a combined item in
this contract, the entity considers that:
• The customer could separately purchase the license without significantly affecting its ability to benefit from
the license.
• Neither the license nor the manufacturing service is significantly modified or customized by the other.
• The entity is not providing a significant service of integrating the license and the manufacturing service into a
combined output.
• The license and the manufacturing service are not highly interdependent or highly interrelated because the
entity would be able to fulfill its promise to transfer the license independent of fulfilling its promise to
subsequently manufacture the drug for the customer. Similarly, the entity would be able to manufacture the
drug for the customer even if the customer had previously obtained the license and initially utilized a
different manufacturer.
Therefore, although the manufacturing service necessarily depends on the license in this contract (that is, the
entity would not contract for the manufacturing service without the customer having obtained the license), the
license and the manufacturing service do not significantly affect each other.
Based on the above analysis, the entity concludes that its promises to grant the license and to provide the
manufacturing service are distinct and there are two performance obligations:
License
Manufacturing service
The entity then assesses the nature of its promise to grant the license. The entity observes that:
The license to patented drug formula has significant standalone functionality in the form of its ability to treat a
disease or condition and, therefore, is a functional IP.
There is no expectation that the entity will undertake activities to change the functionality of the drug formula
during the license period.
Because the IP has significant standalone functionality, any other activities the entity might undertake (for
example, advertising to promote its drug formula or activities to develop other drug products) would not
significantly affect the utility of the licensed IP.
Therefore, the entity concludes that the nature of the entity’s promise in transferring the license is to provide a
right to use the entity’s functional IP. The entity accounts for the license as a performance obligation satisfied at a
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point in time and recognizes revenue for it in when control of the license transfers to the customer (see
Section 6.5) which cannot happen before the customer can use and benefit from the license.
In assessing the nature of the license, the entity does not consider the manufacturing service because it is an
additional promised service in the contract. The entity determines whether the manufacturing service is a
performance obligation satisfied at a point in time or over time in accordance with the discussion in Chapter 6.
EXAMPLE 7-25 (ADAPTED FROM ASC 606-10-55-395 THROUGH 55-399): ACCESS TO IP — NAME AND LOGO OF A
SPORTS TEAM
An entity, a well-known sports team, licenses the use of its name and logo to a customer for two years. The
customer, an apparel designer, has the right to use the sports team’s name and logo on items, including t-shirts,
caps, mugs, and other merchandise for those two years. The customer is required to pay fixed consideration of $4
million, and a royalty of 5% of the sales price of any items using the team name or logo. The customer expects that
the entity will continue to play games and provide a competitive team.
In assessing the goods and services promised to the customer, the entity concludes that:
The only good or service promised to the customer is the license.
The additional activities associated with the license (that is, continuing to play games and provide a competitive
team) do not directly transfer a good or service to the customer.
Based on the above analysis, the entity concludes that the license is the only performance obligation in the
contract.
The entity assesses the nature of the IP license (right to access the entity’s IP or right to use the entity’s IP) and
concludes that it is symbolic IP because:
The utility of the team name and logo to the customer is derived from the entity’s past and ongoing activities of
playing games and providing a competitive team. That is, those activities effectively give value to the IP.
Absent those activities, the team name and logo would have little or no utility to the customer because they
have no standalone functionality. That is, the team name and logo do not have an ability to perform or fulfill a
task separate from their role as symbols of the entity’s past and ongoing activities.
Based on the above analysis, the entity’s promise in granting the license provides the customer with the right to
access the entity’s IP throughout the license period and the entity accounts for the promised license as a
performance obligation satisfied over time.
EXAMPLE 7-26 (ADAPTED FROM ASC 606-10-55-399A THROUGH 55-399J): RIGHT TO USE IP — BROADCAST
RIGHTS
An entity, a television production entity, licenses all the existing episodes of a popular television show (which
consists of the first five seasons) to a customer. The show is presently in its sixth season, and the television
production entity is producing episodes for that sixth season at the time the contract is entered, as well as
promoting the show to attract further viewership. The Season 6 episodes in production are still subject to change
before airing.
The customer obtains the right to broadcast the existing episodes, in sequential order, for three years. The
customer is required to make fixed monthly payments of an equal amount throughout the three-year license period.
The show has been successful through the first five seasons, and the customer is aware that Season 6 is already in
production and the entity continues to promote the show.
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The entity assesses the goods and services promised to the customer and determines that:
The license to broadcast the existing episodes is the only promise in the contract because the entity’s activities
to produce Season 6 and its continued promotion of the show do not transfer a promised good or service to the
customer
The contractual requirement to broadcast the episodes in sequential order is an attribute of the license (that is,
a restriction on how the customer may use the license — see below in this chapter for a discussion of attributes
of a license)
Based on the above analysis, the entity determines that the single license to the completed Seasons 1–5 is the only
performance obligation in this contract.
The entity assesses the nature of the IP license (right to access the entity’s IP or right to use the entity’s IP) and
concludes that the license provides the customer with a right to use its functional IP because:
The existing episodes have substantial standalone functionality at the point in time they are transferred to the
customer because those episodes can be aired in the form transferred without any further participation by the
entity. Therefore, the customer can derive substantial benefit from the completed episodes, which have
significant utility to the customer without any further activities of the entity.
The existing episodes are complete and not subject to change. Thus, there is no expectation that the
functionality of the IP to which the customer has rights will change (that is, the criteria in Section 7.5.2.2 are
not met).
Therefore, the license is a performance obligation satisfied at a point in time. The entity recognizes revenue for the
license on the date that the customer is first allowed to air the licensed content, which is the date when the
content is made available to the customer. The date the customer is first allowed to air the licensed content is the
beginning of the period during which the customer can use and benefit from its right to use the IP.
EXAMPLE 7-27 (ADAPTED FROM ASC 606-10-55-399A THROUGH 55-399J): RIGHT TO USE IP — BROADCAST
RIGHTS
Assume the same facts in Example 7-26 that the contract grants the customer the right to broadcast the existing
episodes, in sequential order, over three years. Additionally, assume that the contract also grants the customer the
right to broadcast the episodes being produced for Season 6 once all of those episodes are completed.
The entity assesses the goods and services promised to the customer and concludes that there are two promised
goods or services in the contract:
The license to the existing episodes (see Example 7-26)
The license to the episodes comprising Season 6, when all of those episodes are completed.
The entity then evaluates whether the license to the existing episodes is distinct from the license to the Season 6
episodes when they are completed. The entity concludes that the two licenses are distinct from each other and are
therefore separate performance obligations because:
Each license is capable of being distinct because the customer can benefit from its right to air the existing
completed episodes on their own and can benefit from the right to air the episodes comprising Season 6, when
they are all completed, on their own and together with the right to air the existing completed content.
Each of the two promises to transfer a license in the contract also is separately identifiable. That is, they do not
together constitute a single overall promise to the customer. This conclusion is based on the following:
• The existing episodes do not modify or customize the Season 6 episodes in production, and the existing
episodes do not, together with the pending Season 6 episodes, result in a combined functionality or changed
content.
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•
The right to air the existing content and the right to air the Season 6 content, when available, are not highly
interdependent or highly interrelated because the entity’s ability to fulfill its promise to transfer either
license is unaffected by its promise to transfer the other.
• Whether the customer or another licensee had rights to air the future episodes would not be expected to
significantly affect the customer’s license to air the existing, completed episodes (for example, viewers’
desire to watch existing episodes from Seasons 1–5 on the customer’s network generally would not be
significantly affected by whether the customer, or another network, had the right to broadcast the episodes
that will comprise Season 6).
The entity assesses the nature of the two separate IP licenses (that is, the license to the existing, completed
episodes of the series and the license to episodes that will comprise Season 6 when completed) and concludes that
both the licenses provide the customer with a right to use its functional IP as it exists at the point in time the
licenses are granted because:
The licensed IP (that is, the completed episodes in Seasons 1–5 and the episodes in Season 6, when completed)
has significant standalone functionality separate from the entity’s ongoing business activities, such as in
producing additional IP (for example, future seasons) or in promoting the show, and completed episodes can be
aired without the entity’s further involvement.
There is no expectation that the entity will substantively change any of the content once it is made available to
the customer for broadcast. That is, the criteria in Section 7.5.2.2 are not met.
The activities expected to be undertaken by the entity to produce Season 6 and transfer the right to air those
episodes constitute an additional promised good (license) in the contract and, therefore, do not affect the
nature of the entity’s promise in granting the license to Seasons 1–5.
The entity recognizes the portion of the transaction price allocated to each license on the date that the customer is
first allowed to first air the content included in each performance obligation. That date is the beginning of the
period during which the customer can use and benefit from its right to use the licensed IP.
7.5.3 Other Licensing Considerations — Attributes of a License Versus Additional License
FASB REFERENCES
ASC 606-10-55-64, ASC 606-10-55-367 through 55-374, ASC 606-10-55-389 through 55-392D, ASC 606-10-55-395
through 55-399, ASC 606-10-55-399A through 55-399J, and ASC 606-10-55-399K through 55-399O
Contractual provisions that explicitly or implicitly require an entity to transfer control of additional goods or services
to a customer (for example, by requiring the entity to transfer control of additional rights to use or rights to access IP
that the customer does not already control) must be distinguished from contractual provisions that explicitly or
implicitly define the attributes of a single promised license (for example, restrictions of time, geographical region, or
use). Attributes of a promised license define the scope of a customer’s right to use or right to access the entity’s IP
and, therefore, do not define whether the entity satisfies its performance obligation at a point in time or over time
and do not create an obligation for the entity to transfer any additional rights to use or access its IP.
EXAMPLE 7-28 (ADAPTED FROM ASC 606-10-55-389 THROUGH 55-392D): RIGHT TO USE IP
An entity, a music record label, licenses a recording of a classical symphony by Beethoven to a customer. The
customer, a consumer products entity, has the right to use the recorded symphony in all commercials, including
television, radio, and online advertisements for three years in Canada starting on January 1, 20X1. The customer is
required to pay fixed consideration of $20,000 per month. The contract does not include any other goods or services
to be provided by the entity. The contract is noncancellable.
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In assessing the goods and services promised to the customer, the entity concludes that:
Its only performance obligation is to grant the license
The following are attributes of the promised license (not separate promises or performance obligations):
• The term of the license (three years)
• The geographical scope of the license, that is, the customer’s right to use the symphony only in Canada
• The defined uses for the recording, that is, in commercials
The entity considers the following in determining whether the promised license provides the customer with a right
to use its IP as it exists at the point in time at which the license is granted:
The Beethoven symphony recording has significant standalone functionality because the recording can be played
in its present, completed form without the entity’s further involvement. The customer can derive substantial
benefit from that functionality regardless of the entity’s further activities or actions. Therefore, the nature of
the licensed IP is functional.
The contract does not require, and the customer does not reasonably expect, that the entity will undertake
activities to change the licensed recording. Therefore, the criteria in Section 7.5.2.2 are not met.
Based on the above analysis, the entity determines that the promised license, which provides the customer with a
right to use the entity’s IP, is a performance obligation satisfied at a point in time. The entity recognizes revenue
when control of the license transfers to the customer (see Section 6.5), which cannot happen before the customer
can use and benefit from the license.
EXAMPLE 7-29 (ADAPTED FROM ASC 606-10-55-389 THROUGH 55-392D): RIGHT TO USE IP — LICENSE RENEWAL
Assume that in Example 7-28, at the end of the first year of the license period, on December 31, 20X1, the entity
and the customer agree to renew the license to the Beethoven symphony for three additional years, subject to the
same terms and conditions as the original license. The entity and the customer agree on a significantly discounted
price of $15,000 per month for the three-year renewal period.
The entity considers the contract combination guidance in Section 2.6 and assesses that the renewal was not
entered at or near the same time as the original license and, therefore, is not combined with the initial contract.
The entity evaluates whether the license renewal must be treated as a new license or the modification of an
existing license in accordance with the guidance on contract modification (see Section 7.3). Assume that the
renewal is distinct. The entity notes that:
If the price for the renewal reflects its standalone selling price, the renewal would be accounted for as a
separate contract with the customer.
If the price for the renewal does not reflect the standalone selling price of the renewal, the renewal would be
accounted for as a modification of the original license contract.
The entity determines that the price for the renewal does not reflect the standalone selling price of the renewal
and hence, the renewal is accounted for as modification of the original license contract, which requires a
reallocation of remaining consideration between the existing license and the renewal.
The entity then determines when to recognize revenue attributable to the license renewal. The entity determines
that the customer cannot use and benefit from the license renewal before the beginning of the three-year renewal
period on January 1, 20X4. The entity concludes that regardless of the amount of consideration that is allocated to
the renewal, revenue for the renewal cannot be recognized before January 1, 20X4.
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EXAMPLE 7-30 (ADAPTED FROM ASC 606-10-55-399K THROUGH 55-399O): DISTINGUISHING MULTIPLE LICENSES
FROM ATTRIBUTES OF A SINGLE LICENSE
On December 15, 20X0, an entity enters a contract with a customer that allows the customer to embed the entity’s
functional IP in two classes of the customer’s consumer products (Class 1 and Class 2) for four years beginning on
January 1, 20X1. Following are the key terms:
During the first year of the license period, the customer can embed the entity’s IP only in Class 1.
Beginning in Year 2 (that is, beginning on January 1, 20X2), the customer is allowed to embed the entity’s IP in
Class 2.
The entity provides (or otherwise makes available — for example, makes available for download) a copy of the IP
to the customer on December 20, 20X0.
There is no expectation that the entity will undertake activities to change the functionality of the IP during the
license period. There are no other promised goods or services in the contract.
In identifying the goods and services promised to the customer in the contract (see Chapter 2), the entity considers
whether the contract grants the customer:
A single promise with an attribute that during Year 1 of the contract the customer is restricted from embedding
the IP in the Class 2 consumer products.
Two promises. That is, a license for a right to embed the entity’s IP in Class 1 for a four-year period beginning on
January 1, 20X1, and a right to embed the entity’s IP in Class 2 for a three-year period beginning on January 1,
20X2.
The entity determines that the provision in the contract stipulating that the right for the customer to embed the
entity’s IP in Class 2 only commences one year after the right for the customer to embed the entity’s IP in Class 1
begins. This provision means that after the customer can begin to use and benefit from its right to embed the
entity’s IP in Class 1 on January 1, 20X1, the entity must still fulfill a second promise to transfer an additional right
to use the licensed IP. That is, the entity must still fulfill its promise to grant the customer the right to embed the
entity’s IP in Class 2. The entity does not transfer control of the right to embed the entity’s IP in Class 2 before the
customer can begin to use and benefit from that right on January 1, 20X2.
The entity concludes that the contract includes two promises:
The four-year license to embed the entity’s IP in Class 1
The three-year license to embed the entity’s IP in Class 2
The entity then concludes that the first promise and the second promise are distinct from each other because:
The customer can benefit from each license on its own and independently of the other. Therefore, each license
is capable of being distinct.
The promise to transfer each license is separately identifiable (that is, distinct in the context of the contract)
because:
• The entity is not providing any integration service with respect to the two licenses (that is, the two rights are
not inputs to a combined output with functionality that is different from the functionality provided by the
licenses independently).
• Neither license significantly modifies nor customizes the other.
• The entity can fulfill its promise to transfer each right to the customer independently of the other. That is,
the entity could transfer either right to the customer without transferring the other.
• Additionally, neither the Class 1 license nor the Class 2 license is integral to the customer’s ability to use or
benefit from the other.
Because each right is distinct, they constitute separate performance obligations.
Based on the nature of the licensed IP and the fact that there is no expectation that the entity will undertake
activities to change the functionality of the IP during the license period, each promise to transfer one of the two
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licenses in this contract provides the customer with a right to use the entity’s IP, and the entity’s promise to
transfer each license is therefore satisfied at a point in time.
The entity determines the point in time at which the revenue allocable to each performance obligation must be
recognized. Because a customer does not control a license until it can begin to use and benefit from the rights
conveyed, the entity recognizes revenue allocated to the Class 1 license no earlier than January 1, 20X1, and the
revenue on the Class 2 license no earlier than January 1, 20X2.
7.5.4 Sales-Based or Usage-Based Royalties
FASB REFERENCES
ASC 606-10-55-64 through 55-65B, ASC 606-10-55-395 through 55-399, ASC 606-10-55-393 and 55-394, and
ASC 606-10-55-375 through 55-382
The standard includes an exception from the requirements in Step 3 to estimate and constrain variable consideration
(see Section 4.3 for discussion on variable consideration) that is a sales-based or usage-based royalty promised in
exchange for a license of IP (referred to hereinafter as “royalty exception”). An entity recognizes revenue for such
sales-based or usage-based royalty only when (or as) the later of the following events occurs:
The subsequent sale or usage occurs
The performance obligation to which some or all of the sales-based or usage-based royalty has been allocated has
been satisfied (or partially satisfied)
SEC STAFF GUIDANCE
Remarks before the 35th Annual SEC and Financial Reporting Institute Conference
Wesley R. Bricker, Deputy Chief Accountant, Office of the Chief Accountant
June 9, 2016
Recognition of Sales- And Usage-Based Royalty
An SEC staff speech stated that ASC 606 does not contain a lag period exception when an entity
is unable to obtain licensee usage information before issuing the financial statements. As such,
entities are required to estimate the unreported royalty usage for the period in which the
usage occurs.
BDO INSIGHTS — ROYALTY EXCEPTION AND ESTIMATING UNREPORTED ROYALTY USAGE
In the context of the SEC Staff Guidance on recognition of sales- and usage-based royalty, an entity that is required
to estimate any unreported royalty usage must develop an accounting policy regarding whether to apply the
variable consideration constraint (see Section 4.3). We believe either approach is acceptable, provided it is
consistently applied.
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BDO INSIGHTS — ROYALTY EXCEPTION AND ALLOCATION CONSIDERATIONS IN STEP 4
The interaction of the royalty exception and the requirement to consider standalone selling prices when allocating
consideration to multiple performance obligations in a contract can lead to patterns of revenue recognition that
differ from the amounts stated in the contract. This arises, for example, in cases where two or more licenses of IP
that are to be transferred to a customer at different points in times are included in a single contract, and the prices
specified in the contract do not reflect the standalone selling prices of the licenses. The “later of” approach in
Section 7.5.4 prevents the amount and timing of revenue recognition from being affected by what might be
considered artificial price allocations in contracts.
APPLICABILITY OF THE ROYALTY EXCEPTION
The royalty exception applies if either of the following requirements are met:
The royalty relates only to a license of IP.
A license of IP is the predominant item to which the royalty relates. For example, the license of IP may be the
predominant item to which the royalty relates when the entity has a reasonable expectation that the customer
would ascribe significantly more value to the license than to the other goods or services to which the royalty
relates.
If either of the above requirements are met, that is, the royalty relates solely or predominantly to a license of IP,
then the royalty exception applies.
If the royalty does not relate solely or predominantly to a license of IP, then the general guidance on estimating the
variable consideration and constraining that estimate applies. See Section 4.3 for discussion on variable
consideration.
In some contracts, an IP license is offered with other goods or services in exchange for a consideration in the form of a
sales-based or usage-based royalty. For example, software licenses with post-contract customer support, franchise
licenses with training services, biotechnology, and pharmaceutical licenses sold with R&D services or a promise to
manufacture a drug for the customer. If a contract includes a license and other goods or services:
Regardless of whether the other goods or services are distinct from the license, the royalty exception applies if the
license is the predominant item in the arrangement.
If a single license is not the predominant item in the contract to which the royalty relates but the royalty
predominantly relates to two or more licenses, the royalty exception applies.
If the license is not the predominant item in the contract, the royalty income represents variable consideration,
which must be estimated and constrained (see Section 4.3 for related discussion) and allocated to each performance
condition, including the license based on relative standalone selling prices unless the allocation exception for
variable consideration or a discount is met (see Chapter 5 for discussion on allocation). The revenue allocated to
each performance obligation is recognized at a point in time or over time based on when control of the good or
service is transferred to the customer (see Chapter 6 and Section 7.5.2 for related discussion).
APPLICABILITY OF THE ROYALTY EXCEPTION — SAAS
The applicability of royalty exception is explicitly limited to licenses of IP and cannot be applied to sales- or usage-
based royalties in exchange for providing other goods or service including SaaS.
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EXAMPLE 7-31 (ADAPTED FROM ASC 606-10-55-395 THROUGH 55-399): ACCESS TO IP — NAME AND LOGO OF A
SPORTS TEAM — ROYALTY EXCEPTION
This example is based on the facts in Example 7-25, which have been repeated here for readability.
An entity, a well-known sports team, licenses the use of its name and logo to a customer for two years. The
customer, an apparel designer, has the right to use the sports team’s name and logo on items, including t-shirts,
caps, mugs, and other merchandise for those two years. The customer is required to pay fixed consideration of $4
million and a royalty of 5% of the sales price of any items using the team name or logo. The customer expects that
the entity will continue to play games and provide a competitive team.
In assessing the goods and services promised to the customer, the entity concludes that:
The only performance obligation in the contract is the license.
The license is a symbolic IP and the entity’s promise in granting the license provides the customer with the right
to access the entity’s IP throughout the license period.
The performance obligation is satisfied over time over the two-year license term.
The entity recognizes the consideration from the customer as follows:
Fixed consideration allocable to the license is recognized over time over the two-year license term but not
before the customer can use and benefit from the license. The entity considers the guidance in Section 6.4 to
identify the measure of progress that best depicts the entity’s performance in satisfying the license.
Variable consideration in the form of a sales-based royalty is recognized in accordance with the royalty
exception because the royalty relates solely to the license that is the only performance obligation in the
contract. The entity recognizes revenue from the sales-based royalty when the customer’s subsequent sales of
items using the team name or logo occur.
That is, the entity concludes that ratable recognition of the fixed consideration of $4 million plus recognition of the
royalty fees as the customer’s subsequent sales occur reasonably depict the entity’s progress toward complete
satisfaction of the license performance obligation (see Section 6.4 for discussion on measure of progress).
EXAMPLE 7-32 (ADAPTED FROM ASC 606-10-55-270 THROUGH 55-279): ALLOCATION OF SALES-BASED ROYALTY
AND APPLICATION OF ROYALTY EXCEPTION
(This is a continuation of Example 5-6 in Chapter 5. The fact pattern is repeated here for readability.)
An entity enters a contract with a customer for two licenses of IP (licenses A and B). Assume each license represents
a separate performance obligation, which is satisfied at a point in time when it is transferred to the customer. The
standalone selling prices of licenses A and B are $1,200 and $1,500, respectively. The consideration for the contract
includes the following:
License A: a fixed amount of $450
License B: a royalty payment of 7.5% of the selling price of the customer’s future sales of products that use
license B
The entity estimates that the amount of sales-based royalties that it will be entitled to in respect of license B will
be $2,250.
The entity then considers the criteria in the variable consideration allocation exception (see Section 5.5) to
determine the allocation of the transaction price to each of the two licenses. The entity determines that although
the sales-based royalties relate solely to the transfer of license B, allocating that variable consideration only to
license B would be inappropriate. This is because allocating $450 to license A and $2,250 to license B would not
reflect a reasonable allocation based on the standalone selling prices of those two licenses. As a result, the entity
must apply the general allocation model based on relative standalone selling prices.
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Allocation of the Fixed Consideration
The entity allocates the fixed amount of $450 to the two licenses based on their standalone selling prices. This
allocation is calculated as:
Product Allocated Transaction Price
License A ($450 x ($1,200/$2,700)) = $200
License B ($450 x ($1,500/$2,700)) = $250
Total $450
Allocation of the Variable Consideration
As the sales by the customer of products that use license B occur, the sales-based royalty will also be allocated to
licenses A and B on a relative standalone selling price basis.
Revenue Recognition at Contract Inception
Assume license A is transferred to the customer three months after contract inception and license B is transferred
at contract inception. Revenue of $200 is recognized for license A three months after the contract inception when
license A is transferred to the customer. Revenue of $250 will be recognized for license B at contract inception
when license B is transferred to the customer.
Recognition of the sales-based royalty allocated to each of the two licenses is deferred to future periods because
the recognition of sales-based royalty before the related sales occur is precluded.
Note that although the royalty is calculated solely based on sales related to license B, the allocation of the fixed
consideration ($450) to license A and the entire sales-based royalties to license B (estimated at $2,250) is
disproportionate in comparison with the standalone selling prices of the two licenses. That is, there is pricing
interdependency between the two licenses, which indicates that some of the royalty generated by license B in fact
relates to the sale of license A, and some of the fixed license fee ($450) stated in the legal contract as relating
solely to license A relates the sale of license B also.
Subsequent Revenue Recognition for Sales-based Royalties
Assume that the royalty in an amount of $300 is due from the customer in the first month based on first month of
sales by the customer of products that use license B. Therefore, the entity recognizes:
$133 ($300 × $1,200 ÷ $2,700) allocated to license A as contract liability. Although the subsequent sale by the
entity's customer has occurred, the performance obligation to which the sales-based royalty has been allocated
has not been satisfied.
$167 ($300 × $1,500 ÷ $2,700) allocated to license B as revenue because license B has been transferred to the
customer and is therefore a satisfied performance obligation.
EXAMPLE 7-33 (ADAPTED FROM ASC 606-10-55-393 AND 55-394): SALES-BASED ROYALTY PROMISED IN
EXCHANGE FOR A LICENSE OF IP AND OTHER GOODS AND SERVICES
A movie distribution entity enters a contract with a customer, an operator of movie theatres. The entity agrees to:
Grant a license that provides the customer/operator the right to show the movie in its theatres for four weeks.
Provide memorabilia from the filming to the operator for display at the operator’s theatres before the beginning
of the four-week airing period.
Sponsor radio advertisements for the movie on popular radio stations in the customer’s geographical area
throughout the four-week airing period.
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In exchange for the license and the additional promotional goods and services, the entity will receive a portion of
the operator’s ticket sales for the movie (that is, variable consideration in the form of a sales-based royalty), which
is the only consideration the entity is entitled to under the contract.
The entity concludes that the license to show the movie is the predominant item to which the sales-based royalty
relates because the entity has a reasonable expectation that the customer would ascribe significantly more value to
the license than to the related promotional goods or services. Therefore, the royalty exception applies. The entity
will recognize all sales-based royalties in revenue as and when the subsequent sale or usage occurs.
EXAMPLE 7-34 (ADAPTED FROM ASC 606-10-55-375 THROUGH 55-382): FRANCHISE RIGHTS AND SALES-BASED
ROYALTY
An entity enters a contract with a customer for the following:
Grant of a franchise license that provides the customer with the right to use the entity’s trade name and sell the
entity’s goods for five years.
Sale of the equipment necessary to operate a franchise store.
The customer is required to pay the following:
In exchange for granting the license, a fixed upfront fee of $1 million and a sales-based royalty of 5% of the
customer’s sales for the term of the license.
In exchange for the equipment, fixed consideration of $150,000, which is payable when the equipment is
delivered.
Identifying Performance Obligations
The entity considers the guidance in Chapter 3 determine which promised goods and services are distinct. The
entity observes that as a franchisor, it has developed a customary business practice to undertake certain activities,
for example, analyzing the consumers' changing preferences and implementing product improvements, pricing
strategies, marketing campaigns, and operational efficiencies to support the franchise name. However, those
activities do not directly transfer goods or services to the customer.
The entity determines that:
The promised goods and services to the customer are the franchise license and the equipment.
The two promises are capable of being distinct because the customer can benefit from the license together with
the equipment that is delivered before the opening of the franchise, and the equipment can be used in the
franchise or sold for an amount other than scrap value.
The two promises are separately identifiable — the license and the equipment are not inputs to a combined item
(that is, they are not fulfilling what is, in effect, a single promise to the customer). In reaching this conclusion,
the entity considers that:
• It is not providing a significant service of integrating the license and the equipment into a combined item,
that is, the licensed IP is not a component of, and does not significantly modify, the equipment.
• The license and the equipment are not highly interdependent or highly interrelated because the entity would
be able to fulfill each promise (to license the franchise or to transfer the equipment) independently of the
other.
Based, on the above, the entity has two performance obligations:
The franchise license
The equipment
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Allocating the Transaction Price
The transaction price includes fixed consideration of $1,150,000 and variable consideration (5% of the customer's
sales from the franchise store). Assume that the standalone selling price of the equipment is $150,000 and the
entity regularly licenses franchises in exchange for 5% of customer sales and a similar upfront fee.
The entity determines that the sales-based royalty must be allocated entirely to the franchise license under the
variable consideration allocation exception (see Section 5.5) because:
The variable consideration relates entirely to the entity’s promise to grant the franchise license.
Allocating $150,000 to the equipment and allocating the sales-based royalty (and the additional $1 million in
fixed consideration) to the franchise license would be consistent with an allocation based on the entity’s relative
standalone selling prices in similar contracts.
Licensing
The entity assesses the nature of the entity’s promise to grant the franchise license and concludes that the nature
of its promise is to provide the customer a right to access the entity’s symbolic IP. In reaching that conclusion, the
entity observes that:
The trade name and logo have limited standalone functionality.
The utility of the goods developed by the entity is derived largely from the goods’ association with the franchise
brand.
Substantially all of the utility inherent in the trade name, logo, and rights to goods granted under the license
stems from the entity’s past and ongoing activities of establishing, building, and maintaining the franchise brand.
The utility of the license is its association with the franchise brand and the related demand for its products.
As the entity grants a license to symbolic IP, it provides the customer a right to access the entity’s IP, and the
entity’s performance obligation to transfer the license is satisfied over time. The entity recognizes the fixed
consideration allocable to the license performance obligation over time when the customer can begin to use and
benefit from the license. The entity identifies the measure of progress that best depicts the entity’s performance in
satisfying the license (see Section 6.4 for related discussion).
Because the sales-based royalty relates specifically to the franchise license, the entity applies the royalty exception
and recognizes revenue from the sales-based royalty as and when the sales occur.
The entity concludes that ratable recognition of the fixed $1 million franchise fee plus recognition of the periodic
royalty fees as the customer’s subsequent sales occur reasonably depicts the entity’s performance toward complete
satisfaction of the franchise license to which the sales-based royalty has been allocated.
BDO INSIGHTS — WHAT IS CONSIDERED A ROYALTY?
The term “royalty” is not defined in ASC 606. There are some cases where it is not clear whether a payment
structure is eligible for the application of the royalty exception. Certain payment terms may be in-substance sales-
or usage-based royalties, even if the contract does not label the payments as royalties. Additionally, there are
situations where the amount of consideration is similar to a bonus and depends on the customer’s subsequent sales
or usage, even though the amount is not calculated based on each sale or usage. For example:
An entity licenses IP in exchange for a payment of $10 million if cumulative sales of the licensee’s products
making use of the IP exceeds $100 million over a specified five-year period.
An entity licenses IP in exchange for payments calculated based on the sales of the licensee’s products that
make use of the IP subject to certain thresholds: no royalty is payable if licensee’s sales are less than $10
million, a royalty of 1% is payable if the sales are between $10 million and $25 million, and a royalty of 2% is
payable if the sales are more than $25 million.
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In our view, the royalty exception applies to these fact patterns because the consideration is based on the sales to
the customer’s customer regardless of whether it is described as a royalty. This conclusion is based on the
discussion in BC70 of ASU 2016-10 that states “… for a license of IP for which the consideration is based on the
customer’s subsequent sales or usage, an entity should not recognize any revenue for the variable amounts until
the uncertainty is resolved (that is, when a customer’s subsequent sales or usage occurs).” We believe the FASB’s
intention is for entities to apply the exception to variable consideration that relates to licenses of IP and is based on
the customer’s subsequent sales or usage regardless of whether it is labelled as a royalty or whether it is structured
so that consideration accumulates evenly over all sales or usage.
However, this view must not be applied to contract clauses that have no economic substance (that is, the payment
is in effect fixed and does not vary based on sales or usage). For example, a contract that includes royalty payments
calculated as a defined percentage of sales but subject to a guaranteed minimum contains a fixed payment equal to
the guaranteed minimum.
BDO INSIGHTS — ROYALTY SUBJECT TO A GUARANTEED MINIMUM AMOUNT
Some licenses of IP include a guaranteed minimum amount, plus incremental royalties above a specified threshold.
In that scenario, the amount and timing of revenue recognition depends on whether the license meets the criteria
for recognition at a point in time (functional IP) or over time (symbolic IP).
When the license meets the criteria for point-in-time revenue recognition, the fixed guaranteed minimum must be
recognized when the performance obligation is satisfied, that is, when the license is transferred to the customer.
This treatment would be consistent with treatment for a license provided on a fixed fee basis.
When the license meets the criteria for over time revenue recognition, an entity must consider the facts and
circumstances and apply judgment to determine an appropriate approach that depicts progress towards the
satisfaction of the performance obligation. In determining the pattern of revenue recognition factors to consider
include:
What is the appropriate measure of progress, time, or the underlying sales or usage?
Is the guaranteed minimum substantive?
Are the royalties expected to exceed the guaranteed minimum?
We believe multiple approaches may be acceptable depending on the facts and circumstances, as illustrated in
Example 7-35 in this chapter.
EXAMPLE 7-35: SALES-BASED ROYALTY PROMISED IN EXCHANGE FOR A LICENSE OF IP WITH MINIMUM GUARANTEE
An entity enters a five-year noncancellable contract to license its IP to a customer. The license requires the
customer to pay a sales-based royalty of 5% of the customer’s gross sales associated with the IP. However, the total
royalties paid over the five-year license term must meet or exceed a minimum guaranteed amount of $5,000. The
expected royalties over the term of the license are:
Year 1 $ 750
Year 2 1,500
Year 3 2,000
Year 4 1,000
Year 5 3,000
Total $ 8,250
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In each of the cases below, it is assumed that:
Actual royalties received in each year equal the above expected royalties.
The customer can use and benefit from the license at the beginning of Year 1.
Case A: Functional IP License — Point in Time Revenue Recognition
If the license represents a right to use functional IP, that is, it meets the criteria for recognition at a point in time,
the entity recognizes revenue as follows:
Year 1 Year 2 Year 3 Year 4 Year 5
Royalties Received $ 750 $ 1,500 $ 2,000 $ 1,000 $ 3,000
Cumulative Royalties 750 2,250 4,250 5,250 8,250
Annual Revenue 5,000 - - 250 3,000
Cumulative Revenue $ 5,000 $ 5,000 $ 5,000 $ 5,250 $ 8,250
Case B: Over Time
If the license represents the right to access symbolic IP, that is, it meets the criteria for recognition over time, the
entity applies judgment in light of the specific facts and circumstances. We believe a number of potential
approaches may be acceptable.
Approach 1: This approach is only appropriate when the royalties are expected to exceed the minimum
guarantee. The entity recognizes the royalty as revenue as the customer’s gross sales associated with the IP
occur. This approach is based on the underlying sales/usage being the appropriate measure on which to recognize
revenue and results in annual revenue being equal to the amount of royalties received each year.
Year 1 Year 2 Year 3 Year 4 Year 5
Royalties Received $ 750 $ 1,500 $ 2,000 $ 1,000 $ 3,000
Cumulative Royalties 750 2,250 4,250 5,250 8,250
Annual Revenue 750 1,500 2,000 1,000 3,000
Cumulative Revenue $ 750 $ 2,250 $ 4,250 $ 5,250 $ 8,250
Approach 2: This approach also is only appropriate when the royalties are expected to exceed the minimum
guarantee. The entity recognizes revenue equal to the lesser of the pro rata portion of the minimum guarantee
earned to date and the royalties earned during the period, subject to a cap of the cumulative royalties earned to
date.
Year 1 Year 2 Year 3 Year 4 Year 5
Royalties Received $ 750 $ 1,500 $ 2,000 $ 1,000 $ 3,000
Cumulative Royalties 750 2,250 4,250 5,250 8,250
Annual Revenue 1,000 1,250 2,000 1,000 3,000
Cumulative Revenue $ 1,000 $ 2,250 $ 4,250 $ 5,250 $ 8,250
Approach 3: The entity recognizes the minimum guarantee (fixed consideration) using a reasonable measure of
progress and recognizes royalties only when cumulative royalties exceed the minimum guarantee. Assuming time
is the measure of progress, $1,000 (that is, $5,000 over 5 years) is recognized in revenue each year. Royalties in
excess of $5,000 are recognized in the year received, which results in the additional $250 and $3,000 recognized
in Years 4 and 5.
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Year 1 Year 2 Year 3 Year 4 Year 5
Royalties Received $ 750 $ 1,500 $ 2,000 $ 1,000 $ 3,000
Cumulative Royalties 750 2,250 4,250 5,250 8,250
Annual Revenue 1,000 1,000 1,000 1,250 4,000
Cumulative Revenue $ 1,000 $ 2,000 $ 3,000 $ 4,250 $ 8,250
BDO INSIGHTS — RECOGNITION OF REVENUE FROM ROYALTIES
Royalty revenue from licenses of IP can only be recognized once the subsequent sale or usage and related
performance have both occurred. This exception applies to licenses of IP regardless of whether the license is a
functional IP satisfied at a point in time or a symbolic IP satisfied over time. Additionally, the five-step revenue
recognition model in ASC 606 provides that revenue from performance obligations satisfied over time is recognized
by measuring the progress towards satisfaction of that performance obligation (see Section 6.4 for discussion on
measure of progress). The objective when measuring progress is to depict an entity's performance in transferring
control of goods or services promised to a customer (that is, the satisfaction of an entity's performance obligation).
The royalty rate for a symbolic IP license (that provides a customer with a right to access an entity’s IP over time)
may not necessarily be constant over the license term. That scenario leads to the question of which guidance takes
precedence:
The requirement to recognize royalties at the rate specified in a contract (that is, royalty exception)
The requirement to measure revenue by reference to the entity’s progress towards satisfying a performance
condition
In our view, while the royalty exception overrides the requirement to estimate and constrain variable consideration,
it does not take precedence over the general revenue recognition requirement to measure revenue by reference to
the entity’s progress towards satisfying a performance condition.
As discussed in BC71 of ASU 2016-10, the requirement that a sales-based or usage-based royalty cannot be
recognized in revenue before the performance obligation to which some or all of the royalty has been allocated has
been fully or partially satisfied (see Section 7.5.4) is intended to make sure that the royalty exception does not
subvert one of the key principles of ASC 606, which is to recognize revenue only when (or as) an entity satisfies a
performance obligation. An entity must recognize revenue from a sales- or usage-based royalty when (or as) the
customer’s subsequent sales or usage occur “unless recognition in that manner would accelerate the recognition of
revenue for the performance obligation to which the royalty solely or partially relates ahead of the entity’s
performance toward complete satisfaction of the performance obligation based on an appropriate measure of
progress.” The following Example 7-36 illustrates revenue recognition considerations for the grant of a symbolic IP
license in exchange for sales-based royalties that decline over the license term.
EXAMPLE 7-36: DECLINING SALES-BASED ROYALTY PROMISED IN EXCHANGE FOR A LICENSE OF SYMBOLIC IP
An entity enters a noncancellable license agreement with a customer for a five-year period in exchange for a sales-
based royalty. The licensee agrees to the following sales-based royalty rates: Year 1: 10%, Year 2: 8%, Year 3: 6%,
Year 4: 4%, Year 5: 2%.
The entity determines that the license gives its customer the right to access the entity's IP as it may exist from time
to time throughout the license period, and not at the point in time when the license was granted. That is, the
license is a symbolic IP satisfied over time.
At contract inception, the entity estimates that:
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The customer’s sales on which the royalty is based will be approximately equal for each of the five years of the
license term.
Any activities undertaken by the entity affecting its IP will be performed on an even and continuous basis
throughout the license period.
Considering the nature of its obligations, the entity determines that following the legal form of the declining royalty
payments (that is, recognizing royalty rates of 10% in Year 1, 8% in Year 2, and so forth) would not appropriately
depict its progress in satisfying its performance obligation for the symbolic IP license.
The entity considers the guidance that sales-based royalties must be recognized on the later of (a) when the sale or
usage occurs and (b) satisfaction of the performance obligation to which the royalty relates. That guidance does not
provide that all of the royalty received/receivable must necessarily be recognized in the period of receipt or in the
period in which the royalty becomes receivable. Rather, that guidance precludes the recognition of royalty revenue
until the performance obligation to which the royalty has been allocated has been satisfied (or partially satisfied).
That is, the entity must consider whether some of the royalty received/receivable must be deferred to ensure
compliance with the requirement to measure revenue based on performance to date.
Based on historical data and estimates, the entity determines that it must initially apply an average expected
royalty rate of 6%. It re-assesses that estimate at each reporting date throughout the license period to determine
whether the rate applied remains appropriate.
7.5.4.1 In-substance Sale of IP
The application of the royalty exception is limited to licenses of IP and is not available for other revenue transactions,
including sales of IP. In some industries (for example, pharmaceuticals) an entity may grant a customer an exclusive
perpetual license to its IP but retain the legal title to the IP. This may be viewed as an in-substance sale of the IP to
the customer. In considering whether the royalty exception is applicable to an in-substance sale of IP, the FASB
clarified in BC78 of ASU 2016-10 that an entity must not discern whether a license to IP is an “in substance sale” of
that IP in deciding whether the royalty exception applies. Rather, an entity considers the legal structure of the
arrangement to determine whether the royalty exception applies. The royalty exception applies if the arrangement is
legally structured as a license of IP, but not if the arrangement is legally structured as a sale of IP. In reaching that
conclusion, the FASB stated that attempting to distinguish between licenses that are, or are not, in substance sales
would add significant complexity to the guidance and that there can be legal differences between a contract for a
license and a sale of IP that it may not be appropriate or feasible to ignore, or attempt to override, from an accounting
perspective.
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7.6 ONEROUS CONTRACTS (LOSS CONTRACTS)
ASC 606 does not include specific guidance for onerous contracts (loss contracts) with customers. Even though ASC 606
superseded the prior revenue recognition guidance in ASC 605, the existing guidance in ASC 605-20, Revenue
Recognition ― Services, and ASC 605-35 related to loss contracts was retained. If an entity has an onerous contract
with a customer, it must consider the applicability of the guidance in ASC 605-20 and ASC 605-35. This section includes
a discussion on the scope of the loss recognition guidance in ASC 605-20 and 605-35.
BDO INSIGHTS — DIVERSITY MAY EXIST IN ACCOUNTING FOR ONEROUS CONTRACTS
Because of a lack of guidance in ASC 606 and the limited scope of the guidance in ASC 605, accounting for onerous
contracts requires the application of professional judgment, based on the facts and circumstances. Diversity in
accounting may exist for onerous contracts that are not specifically within the scope of the guidance in ASC 605-20
and ASC 605-35.
7.6.1 Recognition of Losses for Certain Extended Warranty and Product Maintenance Contracts Under
ASC 605-20
ASC 605-20 has a narrow scope and includes limited but specific guidance on accounting for the provision for losses
related to certain extended warranty and product maintenance contracts. An entity must carefully determine whether
a loss-making warranty or maintenance contract is within the scope of ASC 605-20 and therefore whether the guidance
in ASC 605-20 is applicable.
7.6.1.1 Scope of ASC 605-20
FASB REFERENCES
ASC 605-20-05-1, ASC 605-20-15-1 through 15-3, ASC 605-20-20, and ASC 605-20-25-1
ASC 605-20 is applicable to all entities. It includes guidance on accounting for the provision for losses on separately
priced extended warranty and product maintenance contracts. That guidance is not applicable to:
Product warranties other than extended warranty or product maintenance contracts
Guarantees accounted for as derivatives in accordance with ASC 815 or as insurance contracts in accordance with
ASC 944
FASB REFERENCES
ASC 605-20-20
Extended warranty
“An agreement to provide warranty protection in addition to the scope of coverage of the
manufacturer’s original warranty, if any, or to extend the period of coverage provided by the
manufacturer’s original warranty.”
Product maintenance contracts
“An agreement to perform certain agreed-upon services to maintain a product for a specified
period of time. The terms of the contract may take different forms, such as an agreement to
periodically perform a particular service a specified number of times over a specified period of
time or an agreement to perform a particular service as the need arises over the term of the
contract.”
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Separately priced extended warranty or product maintenance contracts include both of the following characteristics:
These contracts provide warranty protection or product services.
The contract price of these contracts is not included in the original price of the product covered by these contracts.
BDO INSIGHTS — ASC 606 AND ASC 605-20 BOTH APPLY TO CONTRACTS WITHIN THE SCOPE OF ASC 605-20
Entities that enter into extended warranty and product maintenance contracts with customers apply ASC 606 to
account for those contracts. Those entities must consider the scope and requirements in ASC 605-20 to make sure
that a loss contract within the scope of ASC 605-20 is identified and appropriately accounted for. In other words,
the requirements under both ASC 606 and ASC 605-20 are applicable to contracts within the scope of ASC 605-20.
7.6.1.2 Identification and Recognition of a Loss Under ASC 605-20
FASB REFERENCES
ASC 605-20-25-6
“A loss shall be recognized on extended warranty or product maintenance contracts if the sum
of the expected costs of providing services under the contracts and any asset recognized for the
incremental cost of obtaining a contract exceeds the related unearned revenue (contract
liability). Extended warranty or product maintenance contracts shall be grouped in a consistent
manner to determine if a loss exists.”
An entity recognizes a loss first by expensing any asset recognized for the incremental costs of obtaining a contract,
determined in accordance with ASC 340-40 for contracts within the scope of ASC 606 (see Section 7.7). If the loss is
greater than the recognized asset for the incremental costs of obtaining a contract, an entity must recognize a liability
for the excess.
EXAMPLE 7-37: ONEROUS CONSTRUCTION CONTRACT – ASC 605-20
An entity entered a contract with a customer to sell a generator powered by Liquid Natural Gas with a separately
priced maintenance service under which the entity will maintain the generator for five years. Assume that the
contract includes two performance obligations in accordance with ASC 606:
Maintenance services that are satisfied over time
A generator that is satisfied at a point in time
The maintenance services are within the scope of the guidance in ASC 605-20, but the generator is not within the
scope of ASC 605-20 or ASC 605-35 (see Section 7.6.2 for a discussion on ASC 605-35).
In determining whether the guidance on onerous contracts is applicable, the entity considers that ASC 605-20
clearly applies to separately priced extended warranty contracts. The entity concluded that it must apply the
onerous contract guidance in ASC 605-20 to the maintenance performance obligation only and not to the entire
contract. However, because of the guidance in ASC 606 on allocating consideration to performance obligations (see
Chapter 5 for details), a loss may be anticipated at contract inception for the maintenance services only if the
overall contract is priced at a loss. The entity considers the allocation requirements in ASC 606 and determines that
the contract is priced at a loss. The entity recognizes an initial loss on the maintenance services only when that
performance obligation became effective (that is, after the generator was delivered and installed).
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EXAMPLE 7-38: ONEROUS CONSTRUCTION CONTRACT — ASC 605-20
Assume the same facts in Example 7-37 except that the contract was not priced at a loss, and thus no loss was
recognized at contract inception related to the maintenance services. However, at the end of the second year of
the maintenance term, the entity reassesses the expected costs to be incurred during the remaining three years and
concludes that the sum of those costs exceeds the remaining unrecognized revenue. Therefore, the entity
recognizes a loss on the maintenance performance obligation at that time.
7.6.2 Guidance in ASC 605-35 on Construction- and Production-Type Contracts
ASC 605-35 has a narrow scope and includes limited but specific guidance on accounting for the provision for losses
related to certain construction- and production-type contracts. An entity must carefully determine whether a loss-
making construction- and production-type is within the scope of ASC 605-35 and therefore whether the guidance in ASC
605-35 is applicable.
7.6.2.1 Scope of ASC 605-35
FASB REFERENCES
ASC 605-35-05-1 and ASC 605-35-15-1 through 15-6
ASC 605-35 includes guidance on the accounting for a provision for losses on a contract for which specifications are
provided by the customer for the construction of facilities or the production of goods or for the provision of related
services. The definitions of the terms “contract” and “customer” are the same as under ASC 606 (see Sections 2.2
and 1.3 for those definitions, respectively).
BDO INSIGHTS — ASC 606 AND ASC 605-35 BOTH APPLY TO CONTRACTS WITHIN THE SCOPE OF ASC 605-35
Entities that enter into construction- and production-type contracts with customers apply ASC 606 to account for
those contracts. Those entities must consider the scope and requirements in ASC 605-35 to make sure that a loss
contract within the scope of ASC 605-35 is identified and appropriately accounted for. In other words, the
requirements under both ASC 606 and ASC 605-35 are applicable to contracts within the scope of ASC 605-35.
The guidance in ASC 605-35 applies only to contractors, not all entities.
FASB REFERENCES
ASC 605-35-20
Contractor
“A person or entity that enters into a contract to construct facilities, produce goods or render
services to the specifications of a buyer either as a general or prime contractor, as a
subcontractor to a general contractor or as a construction manager.”
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Contracts within the scope of ASC 605-35 are binding agreements between buyers and sellers under which the seller
agrees to perform a service to the buyer's specifications in exchange for compensation. Specifications imposed on the
buyer by a third party (for example, a government or regulatory agency or a bank), or by conditions in the marketplace
are deemed to be buyer's specifications. Following is a non-exhaustive list of examples of contracts covered by ASC
605-35:
Contracts in the construction industry, such as those of general building, heavy earth moving, dredging, demolition,
design-build contractors, and specialty contractors (for example, mechanical, electrical, or paving). Generally, the
type of contract under consideration here is for construction of a specific project, which are generally carried on at
the job site. However, ASC 605-35 also applies in appropriate cases to the manufacturing or building of special items
on a contract basis in a contractor's own plant.
Contracts to design and build ships and transport vessels.
Contracts to design, develop, manufacture, or modify complex aerospace or electronic equipment to a buyer's
specification or to provide services related to the performance of such contracts.
Contracts for construction consulting service, such as under agency contracts or construction management
agreements.
Contracts for services performed by architects, engineers, or architectural or engineering design firms.
Arrangements to deliver software or a software system, either alone or with other products or services, requiring
significant production, software modification, or customization.
Following is a non-exhaustive list of contracts not covered by ASC 605-35:
Sales by a manufacturer of goods produced in a standard manufacturing operation (even when produced to buyers'
specifications) and sold in the ordinary course of business through the manufacturer's regular marketing channels if
such sales are normally recognized as the sale of goods and if their costs are accounted for in accordance with GAAP
of inventory costing.
Sales or supply contracts to provide goods from inventory or from homogeneous continuing production over a period.
Contracts included in a program and accounted for under the program method of accounting. For accounting
purposes, a program consists of a specified number of units of a basic product expected to be produced over a long
period in a continuing production effort under a series of existing and anticipated contracts.
Service contracts of health clubs, correspondence schools, and similar consumer-oriented entities that provide their
services to their clients over an extended period.
Magazine subscriptions.
Contracts of NFPs to provide benefits to their members over a period in return for membership dues.
Contracts for which other U.S. GAAP provides special methods of accounting, such as leases.
Federal government contracts within the scope of ASC 912.
Service transactions between a seller and a purchaser in which, for a mutually agreed price, the seller performs,
agrees to perform later, or agrees to maintain readiness to perform an act or acts, including allowing others to use
entity resources that do not alone produce a tangible commodity or product as the principal intended result. For
example, in a transaction between an architect and the customer of an architect, the architectural services (not
plans) are usually the principal intended result for the customer.
7.6.2.2 Recognizing a Loss Under ASC 605-35
If a contract is within the scope of ASC 605-35, an entity considers the following guidance to determine:
The unit of account for recognizing a loss
The amount and timing of recognizing the loss
Cost-plus-fixed-fee government contracts, which are discussed in ASC 912, Contractors — Federal Government,
other types of cost-plus-fee contracts, or contracts such as those for products or services customarily billed as
shipped or rendered.
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7.6.2.2.1 Unit of Account for Recognizing a Loss Under ASC 605-35
FASB REFERENCES
ASC 605-35-25-7, ASC 605-35-25-10, and ASC 605-35-25-47
An entity determines the need for a provision for losses at the contract level. However, an entity combines contracts
to determine whether a provision for losses is needed when the contract combination criteria in ASC 606 are met. (See
Section 2.6 for a discussion of contract combination guidance under ASC 606.) If contracts are combined, they are
treated as a single unit of account in determining whether a provision for losses is needed.
ACCOUNTING POLICY ELECTION FOR THE UNIT OF ACCOUNT FOR RECOGNIZING A LOSS
As an accounting policy election, an entity may elect to determine the need for provisions for losses at either the
contract level (including contracts that are combined) or the performance obligation level. An entity applies the
requirement in ASC 606 to identify the performance obligations in a contract or in combined contracts. (See
Chapter 3 for a discussion of identifying performance obligations.)
An entity must apply this accounting policy election in the same manner for similar types of contracts.
7.6.2.2.2 Recognition of a Loss Under ASC 605-35
FASB REFERENCES
ASC 605-35-25-45 through 25-46A and ASC 606-35-25-48 through 25-49
For a contract (or combined contracts) on which a loss is anticipated, an entity makes a provision for the entire loss on
the contract when the current estimates of the amount of consideration that an entity expects to receive in exchange
for transferring promised goods or services to the customer, which is determined in accordance with ASC 606 (see
Chapter 3 for related discussion), and contract cost indicate a loss. An entity must make provisions for losses in the
period in which the losses become evident.
To determine the amount that an entity expects to receive, an entity:
Uses the principles in ASC 606 to:
• Determine the transaction price except for the guidance on constraining estimates of variable consideration.
• Allocate the transaction price (see Chapters 4 and 5 for discussion of determining and allocating transaction
price).
Adjusts that amount to reflect the effects of the customer's credit risk.
The costs used to determine the estimated loss on a contract includes all costs to fulfill the contract (see Section 7.7
for a discussion of costs to fulfill a contract). Other factors considered in arriving at the projected loss on a contract
include:
Variable consideration (for example, performance penalties and rewards, and potential price redeterminations).
Nonreimbursable costs on cost-plus contracts.
Change orders that are accounted for as contract modifications in accordance with ASC 606 (see Section 7.3 for a
discussion of contract modifications).
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Losses on a cost-type contract could arise if, for example, the contract provides for guaranteed maximum reimbursable
costs or performance penalties. In recognizing losses for accounting purposes, a contractor:
Uses its normal cost accounting methods to determine the total cost overrun on the contract
Includes provisions for performance penalties in losses
EXAMPLE 7-37: ONEROUS CONSTRUCTION CONTRACT — ASC 605-35
An entity entered a commercial contract to construct a green-energy battery system. The entity considered the
following factors in determining whether the contract is in the scope of ASC 605-35:
The system is being constructed on land owned by the customer
The system is based on engineering designs developed by the entity to meet the customer’s specifications
Based on these facts, the entity concludes that the commercial contract is within the scope of the guidance in
ASC 605-35.
The contract includes a fixed purchase price of $35 million, which is expected to provide a profit to the entity at
contract inception. However, after six months the entity determines that due to unforeseen problems with the
design, the costs to complete the project are now expected to exceed the fixed purchase price. The entity
therefore recognizes a loss at that time in an amount equal to the difference between the remaining expected costs
and the unrecognized revenue.
7.7 CONTRACT COSTS
ASC 340-40 was issued concurrently with ASC 606 and provides specific guidance on the accounting for both the
incremental costs of obtaining and the costs incurred in fulfilling a contract with a customer within the scope of ASC
606. Contract costs are initially recognized as an asset and expensed on a systematic basis that is consistent with the
pattern of transfer to the customer of the good or service to which those costs relate.
7.7.1 Incremental Costs of Obtaining a Contract
FASB REFERENCES
ASC 340-40-25-1 through 25-4
The incremental costs of obtaining a contract are those costs that an entity incurs to obtain a contract with a customer
that it would not have incurred if the contract had not been obtained. A sales commission that is paid only if the
contract with a customer is executed is an example of a cost to obtain a contract.
7.7.1.1 Recognition of Incremental Costs of Obtaining a Contract
An entity is required to recognize the incremental costs of obtaining a contract with a customer as an asset if the
entity expects to recover those costs.
Costs to obtain a contract that would have been incurred regardless of whether the contract was obtained are
recognized as an expense when incurred unless those costs are explicitly chargeable to the customer regardless of
whether the contract is obtained. All costs of running the business, including costs that are incurred with the intention
of obtaining a contract with a customer that are not incremental are expensed unless capitalization is required or
allowed under other area of U.S. GAAP (for example, ASC 360, Property, Plant, and Equipment).
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PRACTICAL EXPEDIENT TO EXPENSE CERTAIN INCREMENTAL COSTS OF OBTAINING A CONTRACT
As a practical expedient, the incremental costs of obtaining a contract can be recognized as an immediate expense
rather than capitalized if the period over which they would otherwise be expensed (or amortized) is one year or
less.
TRG DISCUSSIONS — IDENTIFYING INCREMENTAL COSTS TO OBTAIN A CONTRACT WITH A CUSTOMER
In many cases, identifying incremental costs to obtain a contract may be relatively straight-forward. However, in
other instances, commission structures may be more complex, resulting in questions about which payments qualify
for deferral. The TRG considered this question and concluded that one way to identify the costs to be deferred is to
consider whether the entity would incur the cost if the customer (or the entity) decided at the last minute not to
execute the agreement. If the answer is yes, then the cost is not an incremental cost to obtain the contract.
To illustrate this concept, the TRG considered a scenario in which an entity pays an employee a fixed salary that is
determined annually based on the employee’s prior-year signed sales contracts and projected sales contracts for
the current year. Although the salary is impacted by prior year sales and current year projected sales, it will be
paid regardless of whether any level of sales is achieved. Therefore, the salary paid does not represent an
incremental cost to acquire a contract and should not be deferred.
Conversely, the TRG considered a situation in which an entity pays a commission that is tiered based on the number
of contracts or dollar amount of contracts obtained during an annual period. For example, the employee might earn
no commission for the first nine contracts executed but earn 2% of the value of contracts 10-19 and 5% of the value
of the 20th contract and beyond. The TRG concluded that the commissions paid in this scenario are incremental
costs of obtaining a contract, and thus should be deferred pursuant to the guidance in ASC 340-40-25-1. The TRG
stated that the fact that the commissions are paid on a pool of contracts rather than on each contract individually
does not change the fact that the commissions would not have been incurred had the contracts not been obtained.
The TRG also clarified that the timing of paying the commission is not relevant in determining whether it should be
recognized as an asset, only whether the commission is incremental or not. An entity would apply other U.S. GAAP
to determine whether a liability for the commission payment should be recognized.
EXAMPLE 7-40 (ADAPTED FROM ASC 340-40-55-2 THROUGH 55-4): INCREMENTAL COSTS OF OBTAINING A
CONTRACT
A consulting services provider wins a competitive bid to provide consulting services to a new customer. The entity
incurred the following costs to obtain the contract:
External legal fees for due diligence $ 30,000
Travel costs to deliver proposal 50,000
Sales commissions 20,000
Total costs incurred $ 100,000
REVENUE RECOGNITION UNDER ASC 606 245
The entity recognizes an asset for the $20,000 incremental costs of obtaining the contract arising from the sales
commissions because the entity expects to recover those costs through future fees for the consulting services.
The entity also pays discretionary annual bonuses to sales supervisors based on annual sales targets, overall
profitability of the entity, and individual performance evaluations. The entity does not recognize an asset for the
bonuses paid to sales supervisors because the bonuses are not incremental to obtaining a contract. Rather, the
amounts are discretionary and are based on other factors, including the profitability of the entity and the
individuals’ performance. In other words, the bonuses are not directly attributable to identifiable contracts.
Additionally, the entity observes that the external legal fees and travel costs would have been incurred regardless
of whether the contract was obtained. Therefore, those costs are expensed when incurred, unless they are within
the scope of other U.S. GAAP, in which case, that guidance applies.
EXAMPLE 7-41: INCREMENTAL COSTS OF OBTAINING A CONTRACT
An engineering entity enters a contract with Customer Z to design a water treatment plant. The design project is
expected to take two years to complete. Assume that the entity will transfer the services to Customer Z over time.
To win the project, the entity incurred the following costs as part of developing the bid:
External marketing consultant fee of $100,000
Other internal labor costs totaling $350,000
After being selected as the winning bid, the entity incurred the following costs:
Commission of $120,000 to a PR agent after the contract was signed relating specifically to this contract.
After the contract is signed, the PR agent is paid an additional $50,000 bonus due to exceeding a threshold on
total value of contracts executed year-to-date.
The $100,000 fee paid to the external marketing entity and the $350,000 of internal labor costs were incurred as
part of the bid process to win the contract and would have been incurred by the entity even if it had not been
selected. Therefore, these costs would not be considered an incremental cost of obtaining the contract. The entity
must therefore expense the $100,000 marketing fee and the labor costs as incurred.
The PR agent’s commission and bonus are considered incremental costs of obtaining the contract because these
amounts would not have been paid unless the contract has been signed. Although the bonus is paid based on the
total value of contracts obtained rather than only the current contract, it is still considered an incremental cost to
obtain a contract, consistent with the TRG discussions on identifying incremental costs to obtain a contract with a
customer in Section 7.7.1. The entity must capitalize the PR agent’s commission and bonus as a ‘costs to obtain a
contract’ asset and amortize it over the project period (that is, to reflect the pattern of transfer of the design
service to Customer Z).
EXAMPLE 7-42: INCREMENTAL COSTS OF OBTAINING A CONTRACT — CHANGES TO SALES COMMISSIONS BECAUSE
OF A CONTRACT MODIFICATION
A sales agent receives an initial sales commission based on the contract price when a contract with the customer is
obtained. Assume that the sales commission is appropriately capitalized under ASC 340-40.
Subsequently, the customer modifies the contract to purchase additional goods and the modification does not result
in the entity accounting for the modification as a separate contract (see ASC 606-10-25-12 and 25-13). The sales
agent is paid an additional commission based on the increase in the contract price arising from the modification.
REVENUE RECOGNITION UNDER ASC 606 246
Even though the contract modification is not accounted for as a separate contract, the increase in the contract
price results in additional commission that is incremental to obtaining the modified contract. Therefore, the
additional commission paid is an incremental cost of obtaining a contract and should be capitalized and amortized
(with any unamortized amount relating to the initial commission) on a systematic basis that is consistent with the
transfer to the customer of the remaining goods or services provided over the remaining contractual period.
7.7.2 Costs to Fulfill a Contract
FASB REFERENCES
ASC 340-40-25-5 through 25-8
The guidance in ASC 340-40 is applicable to costs incurred to fulfill a contract with a customer only if the costs are not
within the scope of other U.S. GAAP including:
ASC 330
ASC 340-10-25-1 through 25-4 on preproduction costs related to long-term supply arrangements (see Section 7.7.1
for discussion on that guidance)
ASC 350-40, Intangibles — Goodwill and Other ― Internal Use Software
ASC 360
ASC 985-20, Software ― Costs of Software to be Sold, Leased, or Marketed
An entity must account for the costs incurred in fulfilling a contract in accordance with other applicable GAAP, if those
costs are within the scope of other U.S. GAAP.
7.7.2.1 Recognition of Costs to Fulfill a Contract
An entity recognizes an asset from the costs incurred to fulfill a contract only if those costs meet all the following
criteria:
The costs relate directly to a contract or an anticipated contract that the entity can specifically identify. For
example, costs relating to services provided under renewal of an existing contract or costs of designing an asset
transferred under a specific contract that has not yet been approved but is expected to be approved would be
considered costs to fulfill a contract.
The costs generate or enhance resources of the entity that will be used in satisfying performance obligations in the
future.
The costs are expected to be recovered.
Costs that relate directly to a contract or a specific anticipated contract include:
Direct labor (for example, salaries and wages of employees who provide the promised services directly to the
customer)
Direct materials (for example, supplies used in providing the promised services to a customer)
Allocations of costs that relate directly to the contract or to contract activities (for example, costs of contract
management and supervision insurance and depreciation of tools and equipment used in fulfilling the contract)
Costs that are explicitly chargeable to the customer under the contract
Other costs that are incurred only because an entity entered into the contract such as payments to subcontractors
An entity must expense the following costs when incurred:
General and administrative costs unless those costs are explicitly chargeable to the customer under the contract, in
which case an entity must evaluate whether those costs relate directly to a contract or a specific anticipated
contract
REVENUE RECOGNITION UNDER ASC 606 247
Costs of wasted materials, labor, or other resources not reflected in the price of the contract
Costs that relate to partially or fully satisfied performance obligations in the contract (that is, costs that relate to
past performance)
Costs for which an entity cannot distinguish whether the costs relate to unsatisfied performance obligations or to
satisfied performance obligations (or partially satisfied performance obligations)
BDO INSIGHTS — FULFILLMENT COSTS THAT RELATE TO PARTIALLY SATISFIED PERFORMANCE OBLIGATIONS
Because fulfillment costs that relate to partially satisfied performance obligations cannot be capitalized, we
generally do not expect any costs to fulfill an over-time contract to be capitalized under ASC 340-40 once control of
the goods or services start transferring to the customer, that is, revenue recognition begins.
BC45 of ASU 2016-20 provides the FASB’s expectations that:
Costs historically accounted for within the scope of ASC 605-35 for long-term construction- and production-type
contracts will be accounted for in accordance with ASC 340-40
Adoption of ASC 606 and ASC 340-40 will not require more entities to apply the guidance in ASC 340-10 as compared
with the historical practice.
BDO INSIGHTS — PRE-PRODUCTION COSTS ASSOCIATED WITH LONG-TERM SUPPLY CONTRACTS
Historically there has been diversity in practice in accounting for pre-production costs associated with long-term
supply contracts. ASC 340-10 provides guidance on accounting for the costs of designing and developing “molds,
dies, and other tools that will be used in producing” products under a long-term supply agreement. ASC 606 did not
amend or supersede the guidance provided on pre-production costs in ASC 340-10. Entities that conclude that their
pre-production costs are within the scope of ASC 340-10 should continue to follow that guidance. Entities that
conclude that the guidance in ASC 340-10 is not directly applicable should apply the guidance in ASC 340-40 instead.
EXAMPLE 7-43: CONTRACT COSTS — MANUFACTURING ENTITY
Entity A, a manufacturer of solar panels, enters a contract to sell 10,000 units at $500 per unit to a new customer.
Once the contract was signed, Entity A purchased tooling for $25,000 and incurred engineering costs of $100,000 to
facilitate production of the solar panels. The tooling and engineering activities do not represent a good or service,
which is transferred to the customer (Entity A retains title and control of the tooling and owns and controls of all IP
arising from the activities).
Entity A first determines if any of the costs are within the scope of other U.S. GAAP.
The tooling is an equipment accounted for in accordance with ASC 360.
Entity A determines that the engineering activities are within the scope of ASC 730, Research and Development,
and the costs must be expensed as incurred. This is because the costs meet the definition of development
activities and are not specific to the customer contract. That is, the IP resulting from the engineering efforts can
be used by Entity A to fulfill other future customer orders.
Because all costs incurred to begin delivering under the contract are subject to other U.S. GAAP, the guidance in
ASC 340-40 is not applicable.
REVENUE RECOGNITION UNDER ASC 606 248
7.7.3 Amortization and Impairment of Capitalized Costs
FASB REFERENCES
ASC 340-40-35-1 through 35-5
An entity considers the following guidance for the subsequent measurement of an asset resulting from the deferred
costs to obtain or fulfill a contract with a customer.
7.7.3.1 Amortization of Capitalized Costs
An asset is amortized on a systematic basis that is consistent with the transfer to the customer of the goods or services
to which the asset relates. The asset may relate solely to the current contract, or it may also relate to future
anticipated contracts. An entity must update the amortization to reflect a significant change in the entity’s expected
timing of transfer of the goods or services to which the asset relates to the customer. Such a change is accounted for
as a change in accounting estimate in accordance with ASC 250.
7.7.3.2 Impairment of Capitalized Costs
An entity recognizes an impairment charge in profit or loss to the extent that the carrying amount of a recognized
asset exceeds:
For the purposes of determining the consideration, an entity must:
Consider expected contract renewals and extensions (with the same customer)
Use the principles for determining the transaction price except for the guidance on constraining estimates of
variable consideration (see Chapter 4) and adjust that amount to reflect the effects of the customer’s credit risk
Subsequent reversal of a previously recognized impairment loss is not allowed.
Before an entity recognizes an impairment loss for an asset recognized under ASC 340-40, it must recognize any
impairment loss for assets related to the contract that are recognized in accordance with other U.S. GAAP, including
ASC 330 and ASC 985-20. After applying the impairment test in ASC 340-40-35-3, an entity must include the resulting
carrying amount of the asset recognized under ASC 340-40 in the carrying amount of the asset group or reporting unit
to which it belongs for the purpose of applying the guidance in ASC 350 and ASC 360.
TRG DISCUSSIONS — IMPAIRMENT TESTING OF CAPITALIZED CONTRACT ACQUISITION COSTS
In July 2014, the TRG considered whether entities should factor in cash flows that are expected to arise in any
period covered by customer options to extend or renew the contracts when testing capitalized contract assets for
impairment. TRG members concluded that extension and renewal periods are considered if:
It is expected that the customer will extend or renew the contract.
The contract costs capitalized relate to goods or services that would be transferred to the customer during such
extension or renewal periods.
Consideration
The amount that the entity expects to
receive in the future and has received but
has not recognized as revenue, in
exchange for the goods or services to
which the asset relates
Costs
The costs that directly relate to providing
those goods or services and that have not
been recognized as expenses
(see Section 7.7.1 and Section 7.7.2)
Less
REVENUE RECOGNITION UNDER ASC 606 249
TRG DISCUSSIONS — COMMISSIONS PAID TO OBTAIN A RENEWABLE CONTRACT WITH A CUSTOMER
In certain instances, commissions paid at inception of a customer contract exceed those paid upon contract
renewal, if any. In these situations, careful consideration should be given to the amortization period, including
whether the entity may apply the practical expedient of immediately recording the incremental payments as a
period expense. Specifically, the amortization period for the initial commissions would relate only to the current
contract if the commissions paid at contract renewal are commensurate with the commissions paid at contract
signing.
For example, assume an entity enters a one-year, $100,000 renewable maintenance contract with a customer. The
entity pays a 5% commission on contract signing to its sales agent and will pay that same individual a smaller 1%
commission upon contract renewal. The difference in the renewal rates stems from the entity’s belief that the level
of effort necessary to obtain a renewal is far less than initially entering into a new contract.
The TRG considered this issue and indicated that the level of effort to obtain a contract or renewal should not
factor into determining whether the commission paid on a contract renewal is commensurate with the initial
commission. Instead, a renewal commission is commensurate with an initial commission if the two commissions are
reasonably proportionate to the respective contract values (for example, both are 2% of the amounts invoiced to
customers). Therefore, if a contract does not contain commensurate commissions, the initial commission may relate
to an expected future contract beyond the initial term.
Returning to the example, the initial and renewal commissions are not commensurate. Accordingly, the entity
would not qualify for the practical expedient and instead would defer and amortize the initial commissions over a
period that considers both the initial contract term and any expected renewals. Determining how the initial
commission and subsequent commissions should be amortized may require judgment; multiple approaches may be
acceptable as illustrated in Example 7-44.
EXAMPLE 7-44: INCREMENTAL COSTS OF OBTAINING A CONTRACT — SALES COMMISSIONS PAID FOR A NEW
CONTRACT AND SUBSEQUENT RENEWALS
A sales agent is paid a commission for each contract obtained with a customer as follows:
$100 is paid for a new customer contract.
$60 is paid each time that same customer renews the contract.
The entity concludes that the $60 renewal commission is not considered commensurate with the $100 commission
paid on the initial contract.
The $100 paid for the new customer contract is capitalized at contract inception (unless the practical expedient in
ASC 340-40-25-4 is available and the entity elects it).
The $60 for each renewal is capitalized upon renewal because it is also an incremental cost that would not have
been incurred if the renewal contract was not obtained.
For the $100 capitalized when the new customer contract is obtained, alternative amortization approaches include:
Approach 1: Amortizing the initial $100 over the contract period that includes the specific anticipated renewals
(that in this case is assumed to equal the expected customer relationship life) and amortizing each capitalized
renewal amount over the respective renewal period.
Approach 2: Separating the initial $100 commission into two components: $60 that is amortized over the original
contract term and $40 that is amortized over the period of the initial contract and the specific anticipated
renewals. Upon renewal, the $60 renewal commission is capitalized and amortized over the renewal period.
REVENUE RECOGNITION UNDER ASC 606 250
EXAMPLE 7-45: (ADAPTED FROM ASC 340-40-55-5 THROUGH 55-9) — COSTS THAT GIVE RISE TO AN ASSET
An entity enters a contract with a customer to manage the customer’s information technology data center for five
years. The contract is renewable for subsequent one-year periods. The average customer term is seven years. The
entity incurs the following costs:
Paid an employee a $10,000 sales commission upon the customer signing the contract.
Before providing the services, designed and built a technology platform for the entity’s internal use that
interfaces with the customer’s systems. That platform is not transferred to the customer but will be used to
deliver services to the customer.
Incremental Costs of Obtaining a Contract
The entity recognizes an asset for the $10,000 incremental costs of obtaining the contract for the sales commission
because the entity expects to recover those costs through future fees when providing the services. The entity
amortizes the asset over seven years because the asset relates to the services transferred to the customer during
the initial contract term of five years and the anticipated two one-year renewal periods thereafter.
Costs to Fulfill a Contract
The entity incurred the following initial costs to set up the technology platform:
Design services $ 20,000
Hardware 60,000
Software 45,000
Data migration and testing 50,000
Total costs incurred $ 175,000
The initial set-up costs relate primarily to activities to fulfill the contract but do not transfer goods or services to
the customer. The entity accounts for the initial setup costs as follows:
Hardware costs — accounted for in accordance with ASC 360
Software costs — accounted for in accordance with ASC 350-40
Design services, data migration, and testing — assessed to determine whether an asset can be recognized for the
costs to fulfill the contract. Any resulting asset would be amortized on a systematic basis over the seven-year
period (that is, the five-year contract term and two anticipated one-year renewal periods) that the entity
expects to provide services related to the data center.
Assume that in addition to the initial costs to set up the technology platform, the entity also assigns two employees
who are primarily responsible for providing the service to the customer. Although the costs for the two employees
are incurred as part of providing the service to the customer, the entity concludes that the costs do not generate or
enhance resources of the entity. Therefore, the costs do not meet the criteria to be recognized as an asset under
ASC 340-40 and the entity recognizes the payroll expense for the two employees when incurred.
REVENUE RECOGNITION UNDER ASC 606 251
CHAPTER 8 — PRESENTATION AND
DISCLOSURES
8.1 OVERVIEW
The presentation and disclosure requirements in ASC 606 are significant and detailed. For each contract with a
customer, an entity is required to present any contract asset, contract liability and receivable, as applicable, on its
balance sheet. Additionally, an entity is required to provide comprehensive qualitative and quantitative disclosures to
meet the disclosure objective specified in ASC 606. The disclosure objective of ASC 606 is to provide users of financial
statements with sufficient information to understand the nature, timing, and uncertainty of revenue and cash flows
arising from contracts with customers. Relief from certain disclosure requirements is available for nonpublic entities.
This chapter provides a discussion on the presentation and disclosure requirements and highlights any relief available
for nonpublic entities.
8.2 PRESENTATION
8.2.1 Balance Sheet
FASB REFERENCES
ASC 606-10-45-1 through 45-5
When either party to a contract has performed, an entity presents the contract with a customer in the balance sheet as
either a contract asset or a contract liability on a net basis, depending on the relationship between the entity’s
performance and the customer’s payment. An entity presents any unconditional rights to consideration separately as a
receivable.
The net presentation of remaining rights and performance obligations in a contract with a customer is based on the
notion that an entity’s obligation to perform and the entity’s right to receive consideration from a customer is
interdependent — the right to receive consideration from a customer depends on the entity’s performance and,
similarly, the entity performs only as long as the customer continues to pay. An entity’s net position in a contract is
generally recognized as a contract asset, contract liability, or receivable.
While the guidance uses the terms contract asset and contract liability, an entity is not prohibited from using
alternative descriptions in the balance sheet for those items. If an entity uses an alternative description for a contract
asset, the entity must provide sufficient information to enable a user of the financial statements to distinguish
Scope
Step 1:
Identify the
contract
with a
customer
Step 2:
Identify the
performance
obligation
s in
the contract
Step 3:
Determine
the
transaction
price
Step 4:
Allocate the
transaction
price to
the performance
obligations
Step 5:
Recognize revenue
when or as the
performance
obligation is
satisfied
Other
Topics
Presentation
and
Disclosures
REVENUE RECOGNITION UNDER ASC 606 252
between contract assets (rights to consideration that are conditional) and receivables (rights to consideration that are
unconditional).
BDO INSIGHTS — PRESENTATION OF CONTRACT ASSETS AND CONTRACT LIABILITIES
For a contract that has multiple performance obligations, the contract assets and contract liabilities must be netted
together at the contract level. That is, an entity presents either a contract asset or a contract liability for each
contract (or group of contracts that are required to be combined — see Section 2.6) rather than multiple contract
assets or contract liabilities for the same contract based on individual performance obligations in the contract.
8.2.1.1 Contract Liability
A contract liability is an entity’s obligation to transfer goods or services to a customer for which the entity has received
consideration (or an amount of consideration is due) from the customer. If a customer pays consideration, or an entity
has a right to an amount of consideration that is unconditional (that is, a receivable — see Section 8.2.1.3), before the
entity transfers a good or service to the customer, the entity is required to present the contract as a contract liability
when the payment is made or the payment is due, whichever is earlier.
8.2.1.2 Contract Asset
A contract asset is an entity’s right to consideration in exchange for goods or services that the entity has transferred to
a customer. If an entity performs by transferring goods or services to a customer before the customer pays
consideration or before payment is due, the entity is required to present the contract as a contract asset, excluding
any amounts presented as a receivable (see Section 8.2.1.3 for discussion on receivables).
Additionally, certain upfront payments to a customer (or potential customer) may be accounted for as a contract asset.
See Section 4.6 for a summary of TRG discussions on upfront payment to a customer or potential customer.
A contract asset is assessed for impairment, and any impairment is measured, presented, and disclosed in accordance
with ASC 326.
8.2.1.3 Receivable
A receivable is an entity’s right to consideration that is unconditional. A right to consideration is unconditional if only
the passage of time is required before payment of that consideration is due. For example, an entity would recognize a
receivable if it has a present right to payment even though that amount may be subject to refund in the future. An
entity is required to account for a receivable in accordance with ASC 310, with impairments assessed, measured,
presented, and disclosed in accordance with ASC 326.
BDO INSIGHTS — PRESENTATION OF CONTRACT ASSETS, CONTRACT LIABILITIES, AND RECEIVABLES
Current and non-current portions of contract assets, contract liabilities, and receivables must be separately
presented in a classified balance sheet.
Contract assets and liabilities must be disclosed separately from other balances related to revenues outside the
scope of ASC 606. For example, receivables from contract revenues must be disclosed separately from
receivables that arise from leasing contracts.
Contract assets, contract liabilities, and receivables must be presented separately on the balance sheet or in the
footnotes. Entities must consider other U.S. GAAP (for example, ASC 210-20, Balance Sheet — Offsetting) to
assess whether it is appropriate to net contract assets and contract liabilities that arise from different contracts
(for example, multiple contracts with the same customer) that are not required to be combined in accordance
with ASC 606.
8.2.1.4 Distinguishing Between a Contract Asset and a Receivable
A receivable is distinguished from a contract asset if the receipt of the consideration is unconditional, that is
consideration is solely based on the passage of time. The standard requires that receivables be presented separately
from contract assets because, as stated in BC323 of ASU 2014-09, receivables and contract assets are subject to
different levels of risk. Although both are subject to credit risk, contract assets are also subject to other risks,
REVENUE RECOGNITION UNDER ASC 606 253
including performance risk. Once an entity’s right to consideration becomes unconditional, the contract asset must be
reclassified as a receivable, even if the entity has not generated an invoice (that is, as an unbilled receivable).
BDO INSIGHTS — DETERMINATION OF AN UNCONDITIONAL RIGHT
In some situations, an entity has an unconditional right to consideration in advance of performance. In such
situations, it would be appropriate to record both a receivable and a contract liability. However, an entity must
exercise care in determining whether there is an unconditional right to payment when it has not transferred a good
or service, because this might be difficult to assert. Entities must carefully consider whether the contract terms and
specific facts and circumstances support the existence of unconditional rights to payment.
The following example illustrates the journal entries that are recorded when an entity has an unconditional right to
consideration in advance of performance.
EXAMPLE 8-1 (ADAPTED FROM ASC 606-10-55-284): CONTRACT LIABILITY AND RECEIVABLE — CANCELLABLE
CONTRACT
On March 1, 20X2, a manufacturing entity enters a cancellable contract with a retail customer to sell products,
which the retail customer will resell to end consumers. The contract with the customer has the following terms:
The retail customer is required to pay to the entity $10,000 in advance at the start of the contract before the
receipt of any products.
The retail customer pays $10,000 to the entity on April 1, 20X2.
Each product is determined to have a sales price of $500, and revenue is to be recognized at the point the
retail customer has control of the goods.
The manufacturing entity transfers control of the 100 products on April 30, 20X2 to retail customer. The
manufacturing entity has no further obligations to perform in the contract once transfer of control for the
products has occurred.
On April 1, 20X2, the entity recorded the following journal entry to recognize a contract liability for the cash
received in advance of performance:
Debit Cash $ 10,000
Credit Contract Liability $ 10,000
On April 30, 20X2, the entity recorded the following journal entry to recognize revenue for the 100 products
transferred to the customer:
Debit
Contract Liability
$
10,000
Debit
Receivable
$
40,000
Credit
Revenue
$
50,000
On April 30, 20X2, the manufacturing entity satisfied its performance obligations to transfer control to its
customer of 100 products with a purchase price of $500 each (100 X $500 = $50,000). The manufacturing entity
had previously recognized the advance of $10,000 on its balance sheet as a contract liability. The entity now
derecognizes that contract liability and recognizes $10,000 in revenue because it has satisfied the related
performance obligation. Additionally, the entity recognizes a receivable for the difference, which is calculated
as $50,000 revenue less the $10,000 contract liability (cash collected) = $40,000.
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EXAMPLE 8-2 (ADAPTED FROM ASC 606-10-55-285 AND 55-286): CONTRACT LIABILITY AND RECEIVABLE -
NONCANCELLABLE CONTRACT
On March 1, 20X2, an entity enters into a contract with a customer to sell products on April 30, 20X2 for
consideration of $10,000, paid in advance (that is, before the receipt of any products) on March 30, 20X2. The
customer pays $10,000 to the entity on April 1, 20X2. The entity transfers the product on April 30, 20X2.
The contract becomes noncancellable on March 30, 20X2. Because the contract is now noncancellable, the entity
has an unconditional right to payment for the $10,000. Thus, a receivable is recognized.
On March 30, 20X2, the entity recorded the following journal entry to recognize a receivable and a contract liability
for the noncancellable contract:
Debit
Receivable
$ 10,000
Credit
Contract Liability
$ 10,000
On April 1, 20X2, the entity recorded the following journal entry to recognize the receipt of cash from the customer
and the reversal of the receivable:
Debit
Cash
$ 10,000
Credit
Receivable
$ 10,000
On April 30, 20X2, the entity recorded the following journal entry to recognize revenue for the product transferred
to the customer:
Debit
Contract Liability
$ 10,000
Credit
Revenue
$ 10,000
REVENUE RECOGNITION UNDER ASC 606 255
8.2.1.5 Distinguishing Between a Contract Liability and a Refund Liability
When a customer pays consideration (or consideration is unconditionally due) and the entity has an obligation to
transfer goods or services to the customer, the entity records a contract liability. However, when an entity expects to
refund some or all of the amounts received to the customer, it records a refund liability. As such, a refund liability
does not constitute an obligation to transfer goods or services to the customer in the future. Therefore, we believe
that such liability must be presented separately (if material) from the contract liability.
A customer’s right to exchange one product for another of the same type, quality, condition, and price is not
considered a right to return and hence does not result in a potential refund liability for an entity — see Section 4.3.8
for a discussion of sales with a right of return.
EXAMPLE 8-3 (ADAPTED FROM ASC 606-10-55-287 THROUGH 55-290): CONTRACT ASSET RECOGNIZED FOR THE
ENTITY’S PERFORMANCE
On January 1, 20X2, a retail entity enters a contract to transfer Products X and Y to a customer in exchange for
$10,000. The contract with the customer specifies that:
Product X must be provided first if the entity cannot provide both products at the same time.
Payment for Product X will not be due until both products have been transferred to the customer.
Assume that the retail entity has determined the following:
Product X has a standalone selling price of $3,000 and Product Y has a standalone selling price of $7,000.
Revenue must be recognized at the point in time control of each product transfers to the customer.
The retail entity transfers control of Product X on March 14, 20X2. After resolving supply chain issues, the retail
entity is finally able to transfer control of Product Y on July 1, 20X2.
On March 14, 20X2, the retail entity transfers control of Product X but the entity does not have an unconditional
right to consideration until both products are delivered due to terms and conditions in the contract. Therefore, on
March 14, 20X2, the retail entity recorded the following journal entry to recognize revenue for Product X:
Debit
Contract Asset
$ 3,000
Credit
Revenue
$ 3,000
On July 1, 20X2, the retail entity satisfied its performance obligations to transfer control to its customer of Product
Y. Per the terms of the contract, the retail entity now has an unconditional right to consideration for both products,
and records the following journal entry to recognize revenue for Product Y and a receivable for both products:
Debit Receivable $ 10,000
Credit Contract Asset $ 3,000
Credit Revenue 7,000
EXAMPLE 8-4 (ADAPTED FROM ASC 606-10-55-291 THROUGH 55-294): RECEIVABLE AND REFUND LIABILITY
RECOGNIZED FOR ENTITY’S PERFORMANCE
An entity enters a contract with a new customer on January 1, 20X2, to sell widgets at $15 each. The price per
widget decreases retrospectively to $13 each if the customer buys over 1 million widgets in a calendar year. Below
are some key facts:
There are no other performance obligations in the contract.
Payment is due when the customer receives control of the widget.
When initially assessing the transaction price, the entity determined that the customer would meet the 1
million purchase threshold and as such, estimated that the transaction price for each widget was $13.
On February 1, 20X2, the entity transferred control of 100,000 widgets to the customer.
The journal entry to record the revenue recognized for the first shipment is:
REVENUE RECOGNITION UNDER ASC 606 256
8.2.1.6 Presentation of Other Assets
ASC 606 provides guidance for the capitalization of incremental costs of obtaining a contract and costs to fulfill a
contract. Such capitalized costs should be presented separately from contract assets and contract liabilities.
8.2.2 Income Statement
ASC 606 requires entities to present or disclose revenue recognized from contracts with customers separately from
revenues from other sources of revenue (that is, revenues outside the scope of ASC 606) either on the face of the
income statement or in the footnotes. For example, if not already presented separately on the income statement, an
entity that earns income from contracts from customers and leases could disclose in its footnotes:
Revenues from contracts with customers $ 10,000,000
Lease income 1,300,000
Total revenue $ 11,300,000
Entities must also present the effects of financing (interest income or interest expense) separately from revenue from
contracts with customers in the income statement. BC247 of ASU 2014-09 states that entities may present interest
income as revenue only when interest income represents income from their ordinary activities.
BDO INSIGHTS — PRESENTATION OF AMORTIZATION OF CONTRACT COSTS
While neither ASC 606 nor ASC 340-40 specify the presentation of amortization of contract costs in the income
statement, we believe it is appropriate for an entity to present:
Amortization of costs to obtain a contract with a customer in the same caption as other selling and marketing
costs
Amortization of costs incurred to fulfil a contract in the same caption as cost of sales
We generally do not believe that amortization of capitalized contract costs should be presented as depreciation and
amortization.
Debit Receivable $ 1,500,000
a
Credit Revenue $ 1,300,000
b
Credit Refund Liability $ 200,000
a) Contractual Price of $15 each multiplied by 100,000 products
b) Transaction price of $13 multiplied by 100,000 products
The refund liability represents $2 per widget, which the entity expects to provide the customer for the volume-
based rebate. A receivable is recognized for the contractual amount owed by the customer, as control of the
widgets has passed to the customer and the entity has an unconditional right to payment for these widgets.
REVENUE RECOGNITION UNDER ASC 606 257
8.3 DISCLOSURES
8.3.1 Disclosure Objective
FASB REFERENCES
ASC 606-10-45-1, ASC 606-10-50-1 through 50-23, and ASC 340-40-50-1 through 50-6
The objective of the disclosure requirements in ASC 606 is “for an entity to disclose sufficient information to enable
users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows
arising from contracts with customers.” Additionally, an entity is required to consider the level of detail necessary to
satisfy the disclosure objective and how much emphasis to place on each of the various requirements. An entity
aggregates or disaggregates disclosures so that useful information is not obscured by either the inclusion of a large
amount of insignificant detail or the aggregation of items that have substantially different characteristics.
To help entities achieve this objective, ASC 606 requires quantitative and qualitative disclosures about:
Contracts with customers
Significant judgments, and changes in judgments, made in applying the guidance to those contracts
Assets recognized from the costs to obtain or fulfill a contract with a customer
Judgment is required to determine the appropriate level of aggregation or disaggregation of information needed to
satisfy the overall disclosure objective.
The disclosure requirements in ASC 606 are applicable to each reporting period for which an income statement is
presented and as of each reporting period for which a balance sheet is presented. An entity does not need to disclose
information in accordance with ASC 606 if it has provided the information in accordance with other U.S. GAAP.
BDO INSIGHTS — DISCLOSURES
In BC331 of ASU 2014-09, the FASB acknowledged that the disclosures described in the standard must not be viewed
as a checklist of minimum disclosures. Accordingly, entities do not need to include disclosures that are immaterial
or not relevant; however, entities must include disclosures that are needed to meet the overall disclosure
objective. Entities must make appropriate disclosures for each reporting period for which income statements are
presented and as of each balance sheet date. Entities are not required to repeat disclosures if the information is
already presented in the financial statements as required by other accounting standards.
The following table summarizes the annual and interim disclosures requirements for public and nonpublic entities
under ASC 606:
PUBLIC ENTITIES —
ANNUAL DISCLOSURES
NONPUBLIC ENTITIES —
ANNUAL DISCLOSURES
INTERIM —
DISCLOSURES REQUIRED?
Presentation
Present or disclose
contract assets separately
from contract liabilities
Present or disclose
unconditional rights to
consideration separately
as a receivable
Same requirements
Same requirements
REVENUE RECOGNITION UNDER ASC 606 258
PUBLIC ENTITIES —
ANNUAL DISCLOSURES
NONPUBLIC ENTITIES —
ANNUAL DISCLOSURES
INTERIM —
DISCLOSURES REQUIRED?
Overall
Present or disclose
revenue from contracts
with customers separately
from other sources of
revenue (that is, revenues
outside the scope of
ASC 606)
Present or disclose
impairment or credit
losses on any receivables
or contract assets arising
from contracts with
customers separately from
impairment or credit
losses from other
contracts
Same requirements
Same requirements
Disaggregated Revenue
Disaggregate revenue into
categories that depict
how the nature, amount,
timing, and uncertainty of
revenue and cash flows
are affected by economic
factors
Disclose sufficient
information to enable
users to understand the
relationship of
disaggregated revenue
presented in accordance
with ASC 606 and revenue
information disclosed for
each reportable segment
Nonpublic entities may
elect to omit the
quantitative disaggregation
disclosure guidance in
ASC 606-10-50-5 through
50-6 and ASC 606-10-55-89
through 55-91; however, if
this election is made, the
entity must disclose at a
minimum:
Revenue disaggregated
according to the timing
of transfer of goods or
services (for example, at
a point in time or over
time)
Qualitative information
about how economic
factors (for example,
type of customer,
geographical location of
customers, and type of
contract) affect the
nature, amount, timing,
and uncertainty of
revenue and cash flows
Public entities — Yes
Nonpublic entities —
Optional
REVENUE RECOGNITION UNDER ASC 606 259
PUBLIC ENTITIES —
ANNUAL DISCLOSURES
NONPUBLIC ENTITIES —
ANNUAL DISCLOSURES
INTERIM —
DISCLOSURES REQUIRED?
Contract Balances
Disclose opening and closing
balances of receivables,
contract assets, and contract
liabilities from contracts with
customers
Disclose revenue recognized
in the period that was
included in the contract
liability balance at the
beginning of the period
Explain how timing of
satisfaction of performance
obligations relates to the
typical timing of payment and
the effect those factors have
on the contract asset and
contract liability balances
Provide an explanation of the
significant changes in the
contract asset and contract
liability balances during the
reporting period, including
qualitative and quantitative
information such as:
• Changes due to business
combinations
• Cumulative catch-up
adjustments to revenue
that affect the
corresponding contract
asset or liability
• Impairment of a contract
asset
• A change in the time frame
for a right to consideration
to become unconditional
(that is, for a contract
asset to be reclassified to a
receivable)
• A change in the time frame
for a performance
obligation to be satisfied
(that is, for the recognition
of revenue arising from a
contract liability)
Nonpublic entities can elect
to disclose only the opening
and closing balances of
receivables, contract
assets, and contract
liabilities from contracts
with customers. The other
disclosures in ASC 606-10-
50-8 through 50-10 are
optional.
Public entities —
Disclose opening and
closing balances of
receivables, contract
assets and contract
liabilities from
contracts with
customers and revenue
recognized in the
period that was
included in contract
liability balance at the
beginning of the period
Nonpublic entities —
Optional
REVENUE RECOGNITION UNDER ASC 606 260
PUBLIC ENTITIES —
ANNUAL DISCLOSURES
NONPUBLIC ENTITIES —
ANNUAL DISCLOSURES
INTERIM —
DISCLOSURES REQUIRED?
Performance
Obligations
Provide descriptive information
about performance obligations,
including:
When the entity typically
satisfies its performance
obligations (for example,
upon shipment, upon delivery,
as services are rendered, or
upon completion of service),
including when performance
obligations are satisfied in a
bill-and-hold arrangement
Significant payment terms (for
example, when payment is
typically due, whether the
contract has a significant
financing component,
whether the consideration
amount is variable, and
whether the estimate of
variable consideration is
typically constrained)
The nature of the goods and
services that the entity has
promised to transfer,
highlighting any performance
obligations to arrange for
another party to transfer
goods or services (that is, if
the entity is acting as an
agent)
Obligations for returns,
refunds, and other similar
obligations
Types of warranties and
related obligations
Disclose revenue recognized in
the reporting period from
performance obligations satisfied
(or partially satisfied) in previous
periods (for example, changes in
transaction price).
Nonpublic entities can
elect to disclose only the
descriptive information
about performance
obligations required by
ASC 606-10-50-12. The
other disclosures in ASC
606-10-50-12A and ASC
606-10-50-13 through 50-
15 are optional.
Public — Disclose
revenue recognized in
the reporting period
from performance
obligations satisfied (or
partially satisfied) in
previous periods (for
example changes in
transaction price) and
disclose information
about remaining
performance
obligations.
Nonpublic — Optional
REVENUE RECOGNITION UNDER ASC 606 261
PUBLIC ENTITIES —
ANNUAL DISCLOSURES
NONPUBLIC ENTITIES —
ANNUAL DISCLOSURES
INTERIM —
DISCLOSURES REQUIRED?
Disclose information about
remaining performance
obligations:
Aggregate amount of
transaction price allocated to
performance obligations that
are unsatisfied (or partially
unsatisfied) at the end of the
reporting period
An explanation of when the
entity expects to recognize
revenue from remaining
performance obligations
either on a quantitative basis
using the time bands that
would be most appropriate for
the duration of the remaining
performance obligations or by
using qualitative information
Optional exemptions – ASC
606 includes several optional
exemptions from the
remaining performance
obligations disclosure
requirements. See discussion
in Section 8.3.4.2.1.
REVENUE RECOGNITION UNDER ASC 606 262
PUBLIC ENTITIES —
ANNUAL DISCLOSURES
NONPUBLIC ENTITIES —
ANNUAL DISCLOSURES
INTERIM —
DISCLOSURES REQUIRED?
Significant
Judgments
Disclose the judgments and changes in
judgments that significantly affect the
determination of amount and timing of
revenue in regard to:
Timing of satisfaction of
performance obligations
• For performance obligations
satisfied over time, disclose the
methods used to recognize
revenue and why the method is
appropriate
• For performance obligations
satisfied at a point in time,
disclose significant judgments
made in evaluating when a
customer obtains control of
promised goods or services
Transaction price and amounts
allocated to performance
obligations. Disclose information
about methods, inputs and
assumptions used for:
• Determining the transaction
price, which includes, but is not
limited to, estimating variable
consideration, adjusting the
consideration for the effects of
the time value of money, and
measuring noncash consideration
• Assessing whether an estimate of
variable consideration is
constrained
• Allocating the transaction price,
including estimating standalone
selling prices of promised goods
or services and allocating
discounts and variable
consideration to a specific part
of the contract (if applicable)
• Measuring obligations for
returns, refunds, and other
similar obligations
Nonpublic entities can
elect to disclose only the
information required by
ASC 606-10-50-17 on
significant judgments
that affect the
determination of the
amount and timing of
revenue recognized and
ASC 606-10-50-18(a) on
the method used to
recognize revenue for a
performance obligation
satisfied over time. The
other disclosures in ASC
606-10-50-18(b) through
50-20 are optional.
Not required
REVENUE RECOGNITION UNDER ASC 606 263
PUBLIC ENTITIES —
ANNUAL DISCLOSURES
NONPUBLIC ENTITIES —
ANNUAL DISCLOSURES
INTERIM —
DISCLOSURES REQUIRED?
Costs to obtain or
fulfill a contract
Describe judgments made in
determining the amount of
costs incurred to obtain or
fulfill a contract with a
customer
Describe method of
amortization
Disclose closing balances of
assets recognized from costs
incurred to obtain or fulfill a
contract with a customer by
main category of asset (for
example, costs to obtain
contracts with customers,
precontract costs, and setup
costs)
Disclose amount of
amortization and any
impairment losses recognized
in the reporting period
Not required
Not required
Practical Expedients
Disclose if an entity elects to
use the practical expedient in
either ASC 606-10-32-18
(about the existence of a
significant financing
component) or ASC 340-40-25-
4 (about expensing the
incremental costs of obtaining
a contract).
Not required
Not required
8.3.2 Disaggregated Revenue
FASB REFERENCES
ASC 606-10-55-91
Although the standard requires entities to provide disaggregated revenue information, it does not prescribe specific
categories to disclose. The extent to which revenues are disaggregated depends on the facts and circumstances that
pertain to an entity’s contracts with customers. While some entities might need to use more than one type of revenue
category, others might use only one type of revenue category and still meet the requirements of the standard.
When selecting the type of category (or categories) to comply with the requirement to disclose disaggregated revenue
information, an entity must consider how its revenue information has been presented for other purposes, including all
of the following:
Disclosures presented outside the financial statements (for example, earnings releases, annual reports, or investor
presentations)
Information regularly reviewed by the chief operating decision maker for evaluating the financial performance of
operating segments
REVENUE RECOGNITION UNDER ASC 606 264
Other information that is similar to the types of information identified above and that is used by the entity or users
of the entity’s financial statements to evaluate the entity’s financial performance or make resource allocation
decisions
Following are examples of categories that might be appropriate:
Type of good or service (for example, major product lines)
Geographical region (for example, country or region)
Market or type of customer (for example, government and nongovernment customers)
Type of contract (for example, fixed-price and time-and-materials contracts)
Contract duration (for example, short- and long-term contracts)
Timing of transfer of goods or services (for example, revenue from goods or services transferred to customers at a
point in time and revenue from goods or services transferred over time)
Sales channels (for example, goods sold directly to consumers and goods sold through intermediaries)
DISAGGREGATED REVENUE DISCLOSURES FOR NONPUBLIC ENTITIES
While nonpublic entities are not required to provide full quantitative disaggregated revenue disclosures, those
entities must at a minimum disclose disaggregated revenue according to the timing of transfer of goods or services
(for example, revenue recognized over time and revenue recognized at a point of time).
Additionally, nonpublic entities must disclose qualitative information about how economic factors, such as the type
of customer, geographical location of customers, and type of contract, affect the nature, amount, timing, and
uncertainty of revenue and cash flows.
8.3.2.1 Relationship to Segment Disclosures
FASB REFERENCES
ASC 606-10-55-296 and 55-297
Disclosures that satisfy the objectives of ASC 606 will often present revenues disaggregated at a different level or on a
different basis than segment disclosures. Accordingly, ASC 606 requires entities to disclose sufficient information to
enable financial statement users to understand the relationship between disaggregated revenue disclosures and
revenue information presented for each reportable segment. There is no prescribed format for these disclosures, but
ASC 606 provides an example of such disclosures as follows:
REVENUE RECOGNITION UNDER ASC 606 265
EXAMPLE 8-5 (ADAPTED FROM ASC 606-10-55-296 AND 55-297): DISAGGREGATION OF REVENUE
An entity reports the following segments in accordance with ASC 280: consumer products, transportation, and
energy. The entity disaggregates revenue into primary geographical markets, major product lines, and timing of
revenue recognition for investor presentations.
The entity analyzes the requirements in ASC 606-10-50-5 and concludes that the categories in the investor
presentations can be used to meet the objective of the disaggregation disclosure requirements.
The following table illustrates the disaggregation disclosure by primary geographical market, major product line,
and timing of revenue recognition, including a reconciliation of how the disaggregated revenue ties in with the
consumer products, transportation, and energy segments in accordance with ASC 606-10-50-6.
Segments
Consumer
Products
Transportation Energy Total
Primary Geographical
Markets
North America $ 900 $ 2,000
$ 5,000 $ 7,900
Europe 250 700 1,100 2,050
Asia 750 300 - 1,050
$ 1,900 $ 3,000 $ 6,100 $ 11,000
Major Goods/Service
Lines
Office Supplies $ 550 $ - $ - $ 550
Appliances 900 - - 900
Clothing 450 - - 450
Motorcycles - 500 - 500
Automobiles - 2,500 - 2,500
Solar panels - - 1,000 1,000
Power plant - - 5,100 5,100
$ 1,900 $ 3,000 $ 6,100 $ 11,000
Timing of Revenue
Recognition
Goods transferred at a
point of time
$ 1,900
$ 3,000
$ 1,000
$ 5,900
Services transferred over
time
- - 5,100
5,100
$ 1,900
$ 3,000
$ 6,100
$ 11,000
REVENUE RECOGNITION UNDER ASC 606 266
BDO INSIGHTS — DISAGGREGATED REVENUES
ASC 606 requires entities to disaggregate revenues into categories that reflect how economic factors affect the
nature, amount, timing, and uncertainty of revenue and cash flows. Entities must review other publicly available
information, including other portions of filings such as management’s discussion and analysis, investor presentations
and earnings calls, and consider the revenue information in those other public communications when determining
how to disaggregate revenue in the financial statement disclosures.
8.3.3 Contract Balances
ASC 606 requires specific disclosures regarding contract balances. The purpose of these disclosures is to provide
information about the amount of revenue that is recognized in the current period that is not the result of current
period performance. ASC 606 does not prescribe a specific format for these disclosures — they could be presented in a
tabular or narrative format. Following is an example of potential disclosures using a combination of tabular and
narrative formats:
EXAMPLE 8-6: CONTRACT ASSET AND LIABILITY DISCLOSURES
Entity A discloses receivables from contracts with customers separately in the balance sheet. To satisfy the other
disclosure requirements for contract assets and liabilities, Entity A includes the following information in the notes
to the financial statements:
20X9 20X8 20X7
Contract asset $ 500 $ 700 $ 400
Contract liability (deferred revenue) $ (200) $ (300) $ (100)
Revenue recognized in the period from amounts
included in the contract liability at the beginning of
the period
$ 250 $ 100 $ 200
The timing of revenue recognition, billings, and cash collections results in receivables, contract assets and contract
liabilities. Generally, billing occurs subsequent to revenue recognition, resulting in contract assets. However, we
sometimes receive advances or deposits from our customers before revenue is recognized, resulting in contract
liabilities. Accounts receivable are recorded when the right to consideration becomes unconditional and are
presented separately in the balance sheet. Contract assets and contract liabilities are included in other assets and
deferred revenue, respectively, in the balance sheet.
In 20X9, contract assets and liabilities increased by $20 and $10, respectively, as a result of cumulative catch-up
adjustments due to changes in transaction price. In 20X8, contract assets and liabilities increased by $10 and $30,
respectively, as a result of cumulative catch-up adjustments due to changes in transaction price. In 20X8, contract
assets and liabilities also increased by $300 and $70, respectively, as a result of business combinations.
Although not required, an entity could elect to meet the disclosure requirements related to contract assets and
liabilities by providing a full rollforward of those balances and the applicable activity for each period presented.
8.3.4 Performance Obligations
8.3.4.1 Qualitative Disclosures
ASC 606 requires disclosures that provide descriptive information about an entity’s performance obligations to help
financial statement users understand the nature, amount, timing, and uncertainty of revenue and cash flows arising
from contracts with customers. These disclosures must be entity-specific and complement the entity’s accounting
policy disclosures. Entities must avoid boilerplate language and tailor these disclosures to their specific facts and
circumstances.
REVENUE RECOGNITION UNDER ASC 606 267
ASC 606 also requires entities to disclose the amount of revenue recognized in the current period that relates to
performance obligations satisfied (or partially satisfied) in previous periods. For example, if an entity changes its
estimate of transaction price, the resulting amounts recognized as revenue that relate to performance obligations
satisfied in previous periods must be disclosed.
8.3.4.2 Remaining Performance Obligations
ASC 606 requires entities to disclose information about the transaction price allocated to remaining performance
obligations, as well as when revenue will be recognized related to these obligations. This type of disclosure is
sometimes referred to as a backlog disclosure as it requires disclosure of future revenue to be recorded on partially
completed contracts, but may be different than other backlog disclosures that are sometimes included in filings with
the SEC.
This quantitative disclosure of remaining performance obligations must only include amounts related to performance
obligations in current contracts, that is, excluding renewals that have not been executed and that do not represent
material rights accounted for as performance obligations under current contracts. Additionally, this disclosure does not
include amounts of consideration that have been excluded from the transaction price. Entities must, however, explain
whether any amounts have been excluded from the transaction prices (and therefore excluded from the disclosures),
such as variable consideration that has been constrained.
Explanations of when entities expect to recognize amounts as revenue can be provided either qualitatively or
quantitatively using time bands that are most appropriate for the duration of the remaining performance obligations.
Judgment is required to determine which type of disclosure will be most meaningful to financial statement users.
8.3.4.2.1 Optional Exemptions
OPTIONAL EXEMPTIONS RELATED TO THE DISCLOSURE OF TRANSACTION PRICE ALLOCATED TO
REMAINING PERFORMANCE OBLIGATIONS
The standard includes four optional exemptions related to the disclosure of transaction price allocated to the
remaining performance obligations, which may be applied if any of the following conditions are met:
The performance obligation is part of a contract that has an original expected duration of one year or less.
The entity applies the as-invoiced practical expedient.
The variable consideration is a sales- or usage-based royalty promised in exchange for a license of IP.
The variable consideration is allocated entirely to a wholly unsatisfied performance obligation or to a wholly
unsatisfied distinct good or service that forms part of a single performance obligation.
The standard includes these optional exemptions to avoid instances in which an entity would be required to estimate
variable consideration for disclosure purposes, despite not being required to estimate it for recognition in the financial
statements.
If an entity uses the optional exemptions, it must disclose the nature of the performance obligations, the remaining
duration, and a description of the variable consideration that has been excluded from its disclosures, as well as
whether any consideration is not included in the transaction price.
Following are examples of disclosures on remaining performance obligations and application of optional exemptions.
EXAMPLE 8-7 (ADAPTED FROM ASC 606-10-55-298 THROUGH 55-305): DISCLOSURE OF THE TRANSACTION PRICE
ALLOCATED TO THE REMAINING PERFORMANCE OBLIGATIONS
On March 31, 20X1, an entity enters three contracts with separate customers to provide certain services. Each
contract has a two-year noncancellable term. The description of each contract and the entity’s disclosures of its
remaining performance obligations for those contracts at December 31, 20X1, is included in the following:
REVENUE RECOGNITION UNDER ASC 606 268
Contract 1: Cleaning Services — Fixed Fee — As-invoiced Practical Expedient and Related Exemption from
Disclosing Remaining Performance Obligations
The entity is required to provide cleaning services to the customer over the two-year contract term. The services
are typically provided at least once per month. The customer is required to pay an hourly rate of $15.
The entity observes that it bills the customer a fixed fee for each hour of service provided and the fee corresponds
directly with the value of the entity's performance completed to date. The entity elects to apply the as-invoiced
practical expedient for revenue recognition. As a result, the entity elects to utilize the optional disclosure
exemption and does not provide disclosures on its remaining performance obligations. The entity discloses the
following:
Election of the optional disclosure exemption
The nature of its performance obligation
The remaining contract duration
Description of the variable consideration that has been excluded from the disclosure of remaining performance
obligations
Contract 2: Cleaning and Common Area Maintenance Services — Fixed Fee
The entity is required to provide cleaning and common area maintenance services to the customer as and when
needed over the two-year contract term. However, the entity will provide a maximum of four visits per month. The
customer is required to pay a fixed monthly fee of $200 for both services.
Assume that the services represent an over-time performance obligation. The entity measures its progress toward
satisfaction of the performance obligation using a time-based measure (see Chapters 3 and 6 on identification of
performance obligation and measure of progress for revenue recognition).
Unlike in contract 1, the entity determines that the fixed fee does not correspond directly with the value of the
entity's performance completed to date. Therefore, the entity concludes that the as-invoiced practical expedient
for revenue recognition cannot be elected, and the related optional disclosure relief cannot be used.
The entity provides the following quantitative information in a tabular format with time bands to disclose the
amount of the transaction price that has not yet been recognized as revenue and to illustrate when the entity
expects to recognize that amount as revenue.
20X2
20X3
Total
Revenue expected to be recognized as of
December 31, 20X1
$ 2,400
(a)
$ 600
(b)
$ 3,000
(a) $2,400 = $200 x 12 months
(b) $600 = $200 x 3 months
Contract 3: Cleaning Services — Fixed Fee and Variable Performance Bonus
The entity is required to provide cleaning services to the customer as and when needed over the two-year contract
term. The customer is required to pay a fixed monthly fee of $100 and a one-time performance bonus related to a
one-time regulatory review and certification of the customer's facility, which could range between $0 and $1,000.
Assume the following:
The entity applies the guidance on estimating and constraining variable consideration (see Chapter 4) and
estimates that it will be entitled to $600 of the variable consideration.
The service represents an over-time stand-ready performance obligation; each day represents a distinct service
that forms part of a single performance obligation (see Chapter 3 on identification of performance obligations).
The entity measures its progress toward satisfaction of the performance obligation using a time-based measure
(see Chapter 6 on measure of progress for revenue recognition).
The entity considers the optional exemption from disclosing the information on remaining performance obligations
for variable consideration and determines that the performance bonus does not qualify for that exemption. This is
because:
REVENUE RECOGNITION UNDER ASC 606 269
EXAMPLE 8-8 (ADAPTED FROM ASC 606-10-55-306 AND 55-307): REMAINING PERFORMANCE OBLIGATIONS —
QUALITATIVE DISCLOSURE
On June 1, 20X1, a construction entity enters a contract with a customer to construct a building for a fixed fee of
$5 million. Assume that the construction of the building is a single performance obligation that the entity satisfies
over time. As of December 31, 20X1, the entity has recognized $2 million of revenue. The entity estimates that
construction will be completed in 20X2, but it is possible that the project will be completed in the first half of
20X3.
At December 31, 20X1, the entity is required to disclose the amount of the transaction price that has not yet been
recognized as revenue and when the entity expects to recognize that amount as revenue. The entity observes that
the disclosure can be provided either in a quantitative manner using time bands that are most appropriate for the
duration of the remaining performance obligation or by a qualitative explanation. The entity makes the following
qualitative disclosure because it is uncertain about the timing of revenue recognition:
As of December 31, 20X1, the aggregate amount of the transaction price allocated to the
remaining performance obligation is $3 million, and the entity will recognize this revenue as
the building is completed, which is expected to occur over the next 12-18 months.
8.3.5 Significant Judgments
Financial statement users need information regarding the entity’s critical judgments to understand the nature,
amount, timing, and uncertainty of the entity’s revenues. Accordingly, the standard requires that entities disclose
their judgments (and changes in judgments) that affect the amount and timing of revenue recognition.
8.3.5.1 Judgments Related to Timing
For performance obligations satisfied over time, entities must disclose the methods used to recognize revenue and why
the methods used provide a faithful depiction of the transfer of goods or services. For performance obligations satisfied
The bonus does not represent a royalty in exchange for a license of IP.
The bonus is not allocated to a wholly unsatisfied promise to transfer a distinct service that forms part of a
single performance obligation. Rather, the bonus relates to both satisfied and unsatisfied distinct services that
form part of a single performance obligation.
Therefore, the entity concludes that the optional exemption from disclosing remaining performance obligations is
not applicable. The entity provides the following disclosures:
Quantitative information in a tabular format with time bands to disclose the amount of the transaction price that
has not yet been recognized as revenue and to illustrate when the entity expects to recognize that amount as
revenue.
20X2
20X3
Total
Revenue expected to be recognized as of
December 31, 20X1
$1,500
(a)
$375
(b)
$1,875
(a) Transaction price = $3,000 ($100 x 24 months + $600 variable consideration) recognized
ratably over 24 months at $125 per month. Revenue for 12 months in 20X2 is $1,500 derived
as $125 x 12 months.
(b) $375 = $125 (ratable monthly revenue) x 3 months
Qualitative discussion about the part of the performance bonus that has been excluded from the tabular
disclosure because it was not included in the transaction price in accordance with the guidance on constraining
estimates of variable consideration.
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at a point in time, entities must disclose significant judgments made in evaluating when customers obtain control of
the goods or services.
8.3.5.2 Judgments Related to Transaction Price
Entities must disclose the methods, inputs, and assumptions used when determining the transaction price, which
includes (but is not limited to):
Estimating variable consideration
Adjusting the consideration for the effects of time value of money
Measuring noncash consideration
An entity must also disclose the methods, inputs, and assumptions used when assessing whether an estimate of variable
consideration is constrained.
8.3.5.3 Judgments Related to Amounts Allocated to Performance Obligations
Entities must disclose the methods, inputs, and assumptions used for allocating the transaction price, including
estimating standalone selling prices of goods or services, including any judgments made in allocating discounts and
variable consideration to a specific part of the contract (if applicable).
Similarly, entities must disclose judgments made in measuring obligations for returns, refunds, and other similar
obligations.
8.3.6 Contract Costs
Consistent with the overall disclosure objective, entities must disclose the judgments made in determining the amount
of the costs incurred to obtain or fulfill a contract with a customer as well as the method of amortization.
Additionally, entities must disclose the closing balances of contract costs by main category of asset (for example, costs
to obtain contracts, precontract costs, and setup costs) and the amount of amortization and any impairment losses
recognized in the period.
8.3.7 Practical Expedients and Accounting Policy Elections
ASC 606 provides several practical expedients that are meant to simplify the application of the recognition and
measurement principles of the standard. A public entity must disclose if it elects either of the following practical
expedients:
Significant financing components — An entity need not adjust the promised amount of consideration for the effects
of a significant financing component if, at contract inception, the period between when the entity transfers a
promised good or service to a customer and when the customer pays for that good or service is expected to be one
year or less.
Contract costs — An entity may recognize the incremental costs of obtaining a contract as an expense when
incurred if the amortization period of the asset that otherwise would have been recognized is one year or less.
ASC 606 also provides certain accounting policy elections, which must be disclosed if elected:
Shipping and handling — Whether shipping and handling activities represent a promised service in a contract with a
customer depends on when they are performed. The standard clarifies that if such activities are performed before
the customer obtains control of the good, they are fulfillment activities and not a promised service. On the other
hand, if shipping and handling activities occur after the customer obtains control of the good, such activities would
typically be a separate service provided to the customer for which consideration would need to be allocated.
However, the standard provides that an entity may elect to account for shipping and handling services provided
after the customer obtains control of the good as fulfillment activities rather than as a separate service to the
customer. Entities that make this election must accrue the costs of the shipping and handling if revenue is
recognized for the related good before the fulfillment activities occur.
Sales (and similar) taxes — An entity may make an accounting policy election to exclude from the measurement of
the transaction price all taxes that are both imposed on and concurrent with a specific revenue transaction and
collected by the entity from a customer (for example, sales, use, value added, and some excise taxes). This
accounting policy election does not apply to taxes assessed on an entity’s total gross receipts or imposed during the
inventory procurement process.
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8.3.7.1 Nonpublic Franchisor
A nonpublic franchisor that elects the practical expedient in ASU 2021-02 regarding identification of performance
obligations in Step 2 is required to disclose that fact. An additional disclosure is required if that entity makes the
accounting policy election to recognize preopening services as a single performance obligation. See Section 3.6 for
discussion on the practical expedient and policy election available to nonpublic franchisors.
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APPENDIX A — OTHER BDO BLUEPRINTS
Other publications in BDO’s Blueprint series are available on the BDO Center for Accounting Standards and Reporting
Matters.
Accounting for Leases Under ASC
842
This Blueprint, Accounting for Leases Under ASC 842, guides
professionals through the application of ASC 842.
This Blueprint was updated in April 2023 for FASB amendments to
ASC 842 and BDO Insights.
REVENUE RECOGNITION UNDER ASC 606 273
CONTACTS
BOBBI S. GWINN
Professional Practice Director
- Accounting
214
-665-0749 / b[email protected]
ANGELA NEWELL
Professional Practice Partner
– Accounting
214
-689-5669 / ajnewell@bdo.com
ADAM BROWN
National Managing Partner
- Accounting
214
-665-0673 / ab[email protected]
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Material discussed in this publication is meant to provide general information and should not be acted on without
professional advice tailored to your needs.
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