Revenue from Contracts with Customers ASC 606 Updated

Grant Thornton

January 2022

Revenue from Contracts

with Customers

Navigating the guidance in

ASC 606 and ASC 340-40

This publication was created for general information purposes, and does not constitute professional

advice on facts and circumstances specific to any person or entity. You should not act upon the

information contained in this publication without obtaining specific professional advice. No representation

or warranty (express or implied) is given as to the accuracy or completeness of the information contained

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by any person or entity that relies on the information contained in this publication. This publication is not a

substitute for human judgment and analysis, and it should not be relied upon to provide specific answers.

The conclusions reached on the examples included in this publication are based on the specific facts and

circumstances outlined. Entities with slightly different facts and circumstances may reach different

conclusions, based on considering all of the available information.

The content in this publication is based on information available as of December 31, 2021. We may

update this publication for evolving views as we continue to monitor the implementation process. For the

latest version, please visit grant.thornton.com.

Portions of FASB Accounting Standards Codification

material included in this work are copyrighted by

the Financial Accounting Foundation, 401 Merritt 7, Norwalk, CT 06856, and are reproduced with

permission.

 
 
 
Contents 
1.  Overview ................................................................................................................................................. 6 
1.1  Joint Transition Resource Group for Revenue Recognition ...................................................... 8 
1.2  AICPA Revenue Recognition Task Forces ............................................................................... 9 
1.3  Private Company Council .......................................................................................................... 9 
2.  Scope .................................................................................................................................................... 10 
2.1  Sales of nonfinancial assets .................................................................................................... 11 
2.2  Interaction with other guidance................................................................................................ 12 
  Collaborative arrangements .......................................................................................... 122 
  Contributions received .................................................................................................... 13 
3.  Identify the contract with a customer .................................................................................................... 14 
3.1  Criteria for recognizing a contract............................................................................................ 14 
  The parties have approved the contract and are committed to perform ......................... 17 
  The entity can identify each party’s rights ....................................................................... 18 
  The entity can identify the payment terms for the goods or services .............................. 19 
  The contract has commercial substance ........................................................................ 19 
  It is probable the entity will collect substantially all of the consideration......................... 19 
3.2  Contracts that do not ‘pass’ Step 1 ......................................................................................... 26 
  Reassessing the Step 1 criteria ...................................................................................... 28 
3.3  Contract term ........................................................................................................................... 30 
  Termination provisions .................................................................................................... 30 
3.4  Portfolio practical expedient .................................................................................................... 33 
3.5  Combining contracts ................................................................................................................ 35 
4.  Identify the performance obligations in the contract ............................................................................. 37 
4.1  Identifying promises ................................................................................................................. 37 
  Immaterial promises ........................................................................................................ 40 
  Shipping and handling ..................................................................................................... 43 
  Preproduction activities ................................................................................................... 44 
  Stand-ready promises ..................................................................................................... 45 
4.2  Identifying performance obligations ......................................................................................... 47 
  Capable of being distinct ................................................................................................. 48 
  Distinct within the context of the contract ........................................................................ 49 
4.3  Series of distinct goods or services ......................................................................................... 57 
4.4  Customer options for additional goods or services ................................................................. 62 
  The exercise of a material right ....................................................................................... 72 
4.5  Nonrefundable upfront fees ..................................................................................................... 73 
4.6  Warranties ............................................................................................................................... 78 
5.  Determine the transaction price ............................................................................................................ 82 
5.1  Variable consideration ............................................................................................................. 83 
  Constraint on variable consideration ............................................................................... 90 
  Volume discounts ............................................................................................................ 94 
  Rights of return ................................................................................................................ 99 
  Distinguishing variable consideration from optional goods or services ........................ 102 
  Minimum purchase commitments ................................................................................. 104 
  Reassessing variable consideration.............................................................................. 106 
5.2  Significant financing components .......................................................................................... 107 
  Adjusting for a significant financing component ............................................................ 113 
  Presentation .................................................................................................................. 115 
5.3  Noncash consideration .......................................................................................................... 115 

Contents  4 
 
  Subsequent measurement of noncash consideration ................................................... 118 
5.4  Consideration payable to a customer .................................................................................... 119 
5.5  Changes in the transaction price ........................................................................................... 127 
5.6  Sales and other similar taxes ................................................................................................ 128 
6.  Allocate the transaction price to the performance obligations ............................................................ 129 
6.1  Determining stand-alone selling price ................................................................................... 130 
  Adjusted market assessment approach ........................................................................ 134 
  Expected cost-plus-a-margin approach ........................................................................ 135 
  Residual approach ........................................................................................................ 135 
  Using a combination of approaches .............................................................................. 137 
6.2  Allocating the transaction price to the performance obligations ............................................ 138 
6.2.1     Allocating based on a range of estimated stand-alone selling prices ................................... 141 
6.3    Estimating the stand-alone selling price of an option ................................................................ 143 
  Practical alternative to estimating the stand-alone selling price of an option ............... 145 
6.4  Allocating a discount .............................................................................................................. 148 
6.5  Allocating variable consideration ........................................................................................... 153 
  Allocating variable consideration to a series ................................................................. 156 
6.6  Interaction between allocating discounts and allocating variable consideration ................... 159 
6.7  Changes in transaction price ................................................................................................. 159 
6.8  Allocating a significant financing component ......................................................................... 162 
7.  Recognize revenue when or as performance obligations are satisfied .............................................. 164 
7.1  Control transferred over time ................................................................................................. 166 
  Criteria to recognize revenue over time ........................................................................ 167 
  Methods to measure progress ...................................................................................... 186 
  Right to invoice practical expedient ............................................................................... 193 
  Selecting a single measure of progress ........................................................................ 196 
  Ability to reasonably measure progress ........................................................................ 197 
  Updates to measuring progress .................................................................................... 198 
  Pre-contract activities .................................................................................................... 198 
  Stand-ready obligations ................................................................................................ 199 
7.2  Control transferred at a point in time ..................................................................................... 200 
  Customer acceptance provisions .................................................................................. 204 
7.3  Trial periods ........................................................................................................................... 206 
7.4  Repurchase agreements ....................................................................................................... 206 
  Forwards or calls ........................................................................................................... 207 
  Put options .................................................................................................................... 209 
7.5  Bill-and-hold arrangements ................................................................................................... 211 
7.6  Consignment arrangements .................................................................................................. 214 
7.7  Customer’s unexercised rights .............................................................................................. 215 
8.  Intellectual property licenses .............................................................................................................. 217 
8.1   Scope  .................................................................................................................................... 217 
8.2  Applying Step 2 to license arrangements .............................................................................. 219 
8.3  Determining the nature of the entity’s promise in granting a license ............................ 224 
8.3.1  Functional intellectual property   ................................................................................... 224 
8.3.2  Symbolic intellectual property ....................................................................................... 228 
8.4  Transferring control of the license ......................................................................................... 234 
8.4.1  Renewals ....................................................................................................................... 235 
8.5  Sales-based and usage-based royalties  .............................................................................. 238 
8.5.1  Scope of the exception .................................................................................................. 240 
8.5.2  Contracts with minimum royalty guarantees ................................................................. 242 

Contents  5 
 
9.  Principal versus agent ........................................................................................................................ 246 
9.1  Identifying the specified goods or services promised to the customer   ................................ 248 
9.2  Evaluating control .................................................................................................................. 252 
9.3  Indicators of control  .............................................................................................................. 254 
9.4  Examples of the principal versus agent assessment  ........................................................... 257 
9.5  Reimbursement of out-of-pocket expenses ........................................................................... 262 
10. Modifications ....................................................................................................................................... 264 
10.1  Identifying a modification ....................................................................................................... 264 
  Unpriced change orders and claims.............................................................................. 265 
10.2  Accounting for the modification ............................................................................................. 267 
  Modifications that constitute separate contracts ........................................................... 268 
  Modifications that do not constitute separate contracts ................................................ 270 
11. Contract costs ..................................................................................................................................... 281 
11.1  Costs to obtain a contract ...................................................................................................... 282 
  Commissions ................................................................................................................. 286 
11.2  Costs to fulfil a contract ......................................................................................................... 289 
11.3  Preproduction activities ......................................................................................................... 293 
  Preproduction costs ...................................................................................................... 293 
  Determining the nature of preproduction activities ........................................................ 294 
  Preproduction arrangements ......................................................................................... 295 
11.4  Amortization of contract costs ............................................................................................... 296 
11.5  Impairment of contract costs ................................................................................................. 300 
  Loss contracts ............................................................................................................... 302 
12. Presentation ........................................................................................................................................ 304 
12.1  Contract assets and receivables ........................................................................................... 305 
12.2  Contract liabilities .................................................................................................................. 307 
12.3  Unit of account ....................................................................................................................... 309 
12.4  Offsetting ............................................................................................................................... 310 
12.5  Interaction of ASC 606 with SEC Regulation S-X, Rule 5-03(b) ........................................... 311 
13. Disclosure ........................................................................................................................................... 312 
13.1  Public business entities ......................................................................................................... 313 
  Disaggregation of revenue ............................................................................................ 314 
  Contract balances ......................................................................................................... 318 
  Performance obligations ............................................................................................... 319 
  Significant judgments .................................................................................................... 325 
  Assets recognized from costs to obtain or fulfill a contract ........................................... 326 
  Practical expedients for measurement under ASC 606 and ASC 340-40 .................... 327 
  Interim disclosure requirements .................................................................................... 327 
13.2  Nonpublic entity disclosures .................................................................................................. 328 
  Disaggregation of revenue ............................................................................................ 328 
  Contract balances ......................................................................................................... 331 
  Performance obligations ............................................................................................... 331 
  Significant judgments .................................................................................................... 332 
14.  U.S. GAAP and IFRS comparison ...................................................................................................... 334 
Appendix A: Guidance abbreviations ........................................................................................................ 340 
Appendix B: Changes in this edition  ........................................................................................................ 343 
 

1. Overview

This edition of this publication has been updated to reflect technical accounting amendments issued after

December 2018 and features new illustrative examples and additional Grant Thornton insights. See

Appendix B for a summary of all changes in the 2022 edition compared to the 2018 version of this

publication.

In May 2014 the FASB and the IASB published their largely converged standards on revenue

recognition—ASU 2014-09 and IFRS 15, both titled Revenue from Contracts with Customers—which

supersede and replace virtually all existing U.S. GAAP and IFRS revenue recognition guidance, affecting

almost every revenue-generating entity.

ASC 606-10-10-1

The objective of the guidance in this Topic is to establish the principles that an entity shall apply to

report useful information to users of financial statements about the nature, amount, timing, and

uncertainty of revenue and cash flows arising from a contract with a customer.

The FASB codified the amendments in ASU 2014-09 in Topic 606, Revenue from Contracts with

Customers, which, unlike the voluminous and often industry-specific revenue recognition rules it replaced,

calls for a single, principle-based model for recognizing revenue. The core principle requires an entity to

recognize revenue in a way that depicts the transfer of goods and/or services to a customer in an amount

that reflects the consideration the entity expects to be entitled to in exchange for those goods and/or

services.

To achieve the core principle, an entity is required to apply the following five-step model:

Step 1: Identify the contract with the 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 in the contract.

Step 5: Recognize revenue when (or as) the entity satisfies its performance obligations.

Overview 7

Figure 1.1: The five-step model

In addition to the five-step model, the standard provides implementation guidance on warranties,

customer options, licensing, and other topics discussed in ASC 606-10-55-3 outlined below.

ASC 606-10-55-3

This implementation guidance is organized into the following categories:

a. Assessing collectability (paragraphs 606-10-55-3A through 55-3C)

aa. Performance obligations satisfied over time (paragraphs 606-10-55-4 through 55-15)

b. Methods for measuring progress toward complete satisfaction of a performance obligation

(paragraphs 606-10-55-16 through 55-21)

c. Sale with a right of return (paragraphs 606-10-55-22 through 55-29)

d. Warranties (paragraphs 606-10-55-30 through 55-35)

e. Principal versus agent considerations (paragraphs 606-10-55-36 through 55-40)

f. Customer options for additional goods or services (paragraphs 606-10-55-41 through 55-45)

g. Customers’ unexercised rights (paragraphs 606-10-55-46 through 55-49)

h. Nonrefundable upfront fees (and some related costs) (paragraphs 606-10-55-50 through

55-53)

i. Licensing (paragraphs 606-10-55-54 through 55-60 and 606-10-55-62 through 55-65B)

j. Repurchase agreements (paragraphs 606-10-55-66 through 55-78)

k. Consignment arrangements (paragraphs 606-10-55-79 through 55-80)

l. Bill-and-hold arrangements (paragraphs 606-10-55-81 through 55-84)

m. Customer acceptance (paragraphs 606-10-55-85 through 55-88)

n. Disclosure of disaggregated revenue (paragraphs 606-10-55-89 through 55-91)

An entity recognizes revenue to depict the transfer of promised goods or services

to customers in an amount that reflects the consideration that the

entity expects to be entitled to in exchange for those goods or services.

Step 1:

Identify the

contract

Step 2:

Identify the

performance

obligations

Step 3:

Determine

the

transaction

price

Step 4:

Allocate the

transaction

price

Step 5:

Recognize

revenue

Overview 8

The remainder of this guide

• Summarizes the revenue guidance and certain FASB examples, including the amendments in

subsequent ASUs

• Incorporates discussions, insights, and examples from the Joint Transition Resource Group for

Revenue Recognition (TRG) meetings along with the applicable guidance

• Includes Grant Thornton insights on various topics

• Provides practical insights on how the guidance may differ from legacy GAAP

• Includes illustrative examples to demonstrate how to apply the guidance

At the crossroads: Principle-based model versus rules-based model

The shift in the U.S. GAAP revenue landscape from guidance that tends to be prescriptive to guidance

that is based on a single core principle requires entities to use more judgment and places an emphasis

on the underlying core principle of the guidance. Under the new guidance, an entity needs to apply

judgment, keeping in mind the underlying core principal of the guidance, to align the accounting with

the core principle.

The principle-based model requires entities to make more estimates to reflect the amount of

consideration to which an entity “expects to be entitled,” for example, when transactions have variable

consideration. In addition, the increase in estimates and judgments is accompanied by an increase in

disclosures to describe the estimation methods, inputs, and assumptions.

1.1 Joint Transition Resource Group for Revenue Recognition

Shortly after the standard was issued in 2014, the FASB and IASB formed the TRG to help entities

implement the new revenue guidance. The purpose of the group is to

• Solicit and discuss stakeholder questions arising from implementing the new revenue guidance

• Inform the Boards about implementation issues and recommend action as needed

• Provide a forum for stakeholders to learn about the new guidance

The TRG does not issue authoritative guidance, but the meeting papers (hereinafter referred to as “TRG

Paper XX, Title”) and meeting summaries provide stakeholders with additional insight as to how the new

revenue guidance should be applied, especially for those areas where TRG members reach general

agreement.

In 2016, then Deputy Chief Accountant for the U.S. Securities and Exchange Commission (SEC) Wesley

R. Bricker advised

SEC registrants to follow the TRG discussions, even though they are not authoritative

guidance. In other words, when an entity has a fact pattern similar to one that is included in a FASB or

IASB staff paper or discussed at a TRG meeting, the entity is advised to consult with the SEC staff if it

reaches a different conclusion on applying the guidance than the conclusion reached by the TRG.

Remarks before the 2016 Baruch College Financial Reporting Conference, May 5, 2016.

9 Overview

All TRG meeting papers prepared by the FASB and/or IASB staff, including examples and staff views

as well as archived meetings and meeting summaries, can be found on the TRG homepage on the

FASB website.

1.2 AICPA Revenue Recognition Task Forces

The AICPA formed 16 industry task forces to address industry-specific implementation questions and to

help develop a new accounting and auditing guide on revenue recognition. The industries involved with

this project included aerospace and defense, airlines, asset management, broker-dealers, construction

contractors, depository institutions, gaming, health care, hospitality, insurance, not-for-profit, oil and gas,

power and utility, software, telecommunications, and timeshare.

The AICPA’s Audit and Accounting Guide: Revenue Recognition contains accounting and auditing

overviews as well as industry-specific considerations for the 16 industries. While the guide contains

interpretive guidance, it does not create new GAAP and is not authoritative.

1.3 Private Company Council

The Private Company Council (PCC) is the primary advisory body to the FASB on private company

accounting issues. The PCC asked the FASB staff to prepare certain educational memos to assist with

private companies’ implementation of ASC 606. These memos, which are not authoritative, can be

found on the Implementation Q&A section of the FASB website.

2. Scope

ASC 606 applies to all contracts with customers to provide goods or services that are outputs of the

entity’s ordinary course of business in exchange for consideration, unless specifically excluded from the

scope of the new guidance, as described below.

An entity should apply the guidance in ASC 606 to all contracts with customers, except the following:

• Lease contracts within the scope of ASC 840 or ASC 842

• Contracts within the scope of ASC 944

• Guarantees (other than product or service warranties) within the scope of ASC 460

• Nonmonetary exchanges between entities in the same line of business to facilitate sales to customers

or potential customers

• Financial instruments and other contractual rights and obligations within the scope of

ASC 310, ASC 320, ASC 323, ASC 325, ASC 405, ASC 470, ASC 815, ASC 825, and ASC 860

The new revenue guidance creates Subtopic 924-815, which excludes fixed-odds wagering contracts

from the derivatives guidance. As a result, fixed-odds wagering contracts should be accounted for in

accordance with the guidance in ASC 606.

TRG area of general agreement: In or out of scope?

The TRG discussed the following types of arrangements and reached general agreement on the

applicability of the scope of ASC 606 as follows:

• Credit card fees: At its July 2015 meeting,

the TRG reached general agreement that credit card

fees accounted for under ASC 310 are not within the scope of ASC 606. In other words, TRG

members expect the conclusion under both legacy guidance and ASC 606 to be the same when

evaluating various revenue streams from credit card programs. An SEC observer to the meeting

cautioned, however, that entities should not assume that any fee connected to a credit card or any

arrangement labeled as a credit card lending arrangement would automatically fall within the scope

of ASC 310. In other words, the entity must assess whether the nature of the overall arrangement

is a credit card lending arrangement and, if not, the entity should not presume that the

arrangement is entirely within the scope of ASC 310.

TRG Paper 36, Scope: Credit Cards.

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.

Scope 11

• Credit card reward programs: At its July 2015 meeting,

the TRG also generally agreed that an

entity must apply judgment and consider all facts and circumstances of the specific credit

cardholder award program in question to determine whether the reward program is within the

scope of ASC 606. If an entity determines that all fees related to the program, including the credit

card fees, are within the scope of ASC 310, the program would not be within the scope of

ASC 606.

• Servicing and sub-servicing fees: At its April 2016 meeting,

the TRG generally agreed that

servicing and sub-servicing fees are in the scope of ASC 860 and therefore are excluded from the

scope of ASC 606.

• Deposit-related fees: At its April 2016 meeting,

the TRG generally agreed that deposit-related

fees are within the scope of ASC 606. While the deposit-related liability is within the scope of

ASC 405 and is excluded from the scope of ASC 606, ASC 405 lacks accounting guidance for

deposit-related fees. Therefore, it is appropriate to apply the guidance in ASC 606 to deposit-

related fees.

• Carried interest: At its April 2016 meeting,

the TRG members generally agreed that incentive-

based performance fees in the form of an allocation of capital from an investment fund under

management, referred to as a “carried interest,” are within the scope of ASC 606. Some TRG

members indicated that a reasonable alternative view could be that the carried interest is an equity

arrangement, because it is, in form, an interest in the entity. Some TRG members noted this

alternative view may lead to questions regarding whether an asset manager should consolidate the

fund. The SEC staff observer stated that the SEC staff would most likely accept the application of

ASC 606 to carried interest arrangements but also noted that there could be a basis for following

an ownership model. The SEC staff would expect entities that apply an ownership model to include

an analysis of the consolidation model under ASC 810, Consolidation, the equity method of

accounting under ASC 323, Investments – Equity Method and Joint Ventures, or other relevant

guidance.

• Preproduction activities: At its November 2015 meeting,

the TRG discussed whether certain

pre-production costs fall within the scope of ASC 340-10 or ASC 340-40. See additional discussion

at Section 11.3.

2.1 Sales of nonfinancial assets

The new revenue guidance adds ASC 610-20 to provide guidance on accounting for sales of nonfinancial

assets and, therefore, amends ASC 360 and ASC 350. ASC 610-20 requires entities to apply the

guidance in ASC 606 on contract existence, control, and measurement to transfers of nonfinancial assets

that are not an output of the entity’s ordinary activities.

Ibid

TRG Paper 52, Scoping Considerations for Financial Institutions.

Ibid.

TRG Paper 50, Scoping Considerations for Incentive-based Capital Allocations, Such as Carried

Interest.

TRG Paper 46, Pre-production costs.

Scope 12

Sales of nonfinancial assets

Quality Paper (QP) is a manufacturer of paper goods that operates in seven locations across the United

States. QP builds a new facility in Omaha and sells its existing facility in Lincoln to a third party. The

sale of manufacturing facilities is not an output of QP’s ordinary activities; however, QP should still apply

the contract existence, control, and measurement provisions in ASC 606 to the sale of its Lincoln facility.

Applying those provisions, however, will not affect QP’s income statement presentation of any resulting

gain or loss from the facility sale.

2.2 Interaction with other guidance

A contract with a customer may be partially within the scope of ASC 606 and partially within the scope of

other ASC Topics. If the other Topics specify how to separate and/or measure a portion of the contract,

then that guidance should be applied first. The amounts measured under other Topics should be

excluded from the transaction price that is allocated to performance obligations under ASC 606. If the

other Topics do not stipulate how to separate and/or measure a portion of the contract, then ASC 606

should be used to separate and/or measure that portion of the contract.

ASC 606-10-15-4

A contract with a customer may be partially within the scope of this Topic and partially within the scope

of other Topics listed in paragraph 606-10-15-2.

a. If the other Topics specify how to separate and/or initially measure one or more parts of the

contract, then an entity shall first apply the separation and/or measurement guidance in those

Topics. An entity shall exclude from the transaction price the amount of the part (or parts) of the

contract that are initially measured in accordance with other Topics and shall apply paragraphs

606-10-32-28 through 32-41 to allocate the amount of the transaction price that remains (if any) to

each performance obligation within the scope of this Topic and to any other parts of the contract

identified by paragraph 606-10-15-4(b).

b. If the other Topics do not specify how to separate and/or initially measure one or more parts of the

contract, then the entity shall apply the guidance in this Topic to separate and/or initially measure

the part (or parts) of the contract.

2.2.1 Collaborative arrangements

A collaborative arrangement is defined as a contractual arrangement under which two or more parties

actively participate in a joint operating activity and are exposed to significant risks and rewards that

depend on the activity’s commercial success. Therefore, an entity that enters into arrangements such as

those for collaborative research and development activities will need to evaluate the particular facts and

circumstances of each contract to determine if the collaborative arrangement participant is a customer.

The FASB issued ASU 2018-18 to clarify the interaction between the guidance for certain collaborative

arrangements in ASC 808 and ASC 606. In particular, the amendments in the ASU clarify that certain

transactions between collaborative arrangement participants should be accounted for as revenue under

ASC 606 if the collaborative arrangement participant is a customer with respect to the “unit of account”

(identified as a promised good or service, or a bundle of goods or services, that is distinct within the

Scope 13

collaborative arrangement under the related guidance in ASC 606). An entity that accounts for this type of

transaction under ASC 606 should apply all of the guidance in ASC 606, including the recognition,

measurement, presentation, and disclosure requirements. Also, a transaction with a collaborative

arrangement participant that is not directly related to sales to third parties should not be presented

together with revenue recognized under ASC 606 if the collaborative arrangement participant is not a

customer.

The amendments in ASU 2018-18 are effective for public business entities in fiscal years, and in interim

periods within those fiscal years, beginning after December 15, 2019. All other entities have an additional

year. Early adoption is permitted; however, entities may not adopt the amendments prior to adopting

ASC 606.

2.2.2 Contributions received

The FASB issued ASU 2018-08 to address concerns about the diversity in accounting for grants and

contracts for not-for-profit (NFP) entities.

The amendments provide a framework for determining whether a particular transaction is an exchange

transaction, contribution transaction, or other type of transaction, such as an agency transaction, and

whether a contribution is conditional or unconditional. Exchange transactions are a form of reciprocal

transaction, which means that both parties give and receive something that has economic value. In

contrast, contributions are a form of nonreciprocal transaction, meaning that the resource provider neither

expects to receive, nor receives, economic value in return for its donation.

Exchange transactions are excluded from the scope of ASC 958-605 and instead are accounted for under

other guidance, including ASC 606.

For additional information, refer to Grant Thornton’s New Developments Summary 2018-06, “FASB

clarifies scope of contribution accounting: Impact on both recipients and resource providers.”

3. Identify the contract with a customer

Because the guidance in ASC 606 applies only to contracts with customers, the first step in the model is

to identify those contracts.

ASC 606-10-25-2

A contract is an agreement between two or more parties that creates enforceable rights and

obligations. Enforceability of the rights and obligations in a contract is a matter of law. Contracts can be

written, oral, or implied by an entity’s customary business practices. The practices and processes for

establishing contracts with customers vary across legal jurisdictions, industries, and entities. In

addition, they may vary within an entity (for example, they may depend on the class of customer or the

nature of the promised goods or services). An entity shall consider those practices and processes in

determining whether and when an agreement with a customer creates enforceable rights and

obligations.

The guidance in ASC 606-10-25-2 makes it clear that the rights and obligations in a contract must be

“enforceable” before an entity applies the five-step revenue model. Enforceability is a matter of law, so an

entity needs to consider the local relevant legal environment to determine whether rights and obligations

are enforceable. That said, while the contract must be legally enforceable, oral or implied promises may

give rise to performance obligations in the contract under Step 2 (Section 4).

To assist entities in determining if an arrangement is within the scope of ASC 606, the guidance specifies

five criteria that the arrangement must meet.

3.1 Criteria for recognizing a contract

Step 1 serves as a “gate” through which a contract must pass before an entity applies the later steps of

the model to that contract. In other words, if at the inception of an arrangement, an entity concludes that

the criteria below are not met, it should not apply Steps 2 through 5 of the model until it determines that

the Step 1 criteria are subsequently met. Significant judgment may be required to conclude whether an

accounting contract exists. When a contract meets the five criteria and “passes” Step 1, the entity will not

reassess the Step 1 criteria unless there is an indication of a significant change in facts and

circumstances (Section 3.2.1).

A contract is an agreement between two or more parties that creates enforceable rights

and obligations.

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.

Identify the contract with a customer 15

An accounting contract exists only when an arrangement with a customer meets the following five criteria:

• The parties have approved the contract and are committed to perform their contractual obligations.

• The entity can identify each party’s rights.

• The entity can identify the payment terms.

• The contract has commercial substance.

• It is probable that the entity will collect substantially all of the consideration to which it expects to be

entitled.

If the arrangement does not meet the five criteria, an accounting contract does not exist, even though a

legal contract may exist, and the entity follows the guidance in ASC 606-10-25-7 as described in

Section 3.2.

ASC 606-10-25-1

An entity shall account for a contract with a customer that is within the scope of this Topic only when all

of the following criteria are met:

a. The parties to the contract have approved the contract (in writing, orally, or in accordance with

other customary business practices) and are committed to perform their respective obligations.

b. The entity can identify each party’s rights regarding the goods or services to be transferred.

c. The entity can identify the payment terms for the goods or services to be transferred.

d. The contract has commercial substance (that is, the risk, timing, or amount of the entity’s future

cash flows is expected to change as a result of the contract).

e. It is 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 (see

paragraphs 606-10-55-3A through 55-3C). In evaluating whether collectibility of an amount of

consideration is probable, an entity shall consider only the customer’s ability and intention to pay

that amount of consideration when it is due. The amount of 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 may offer the customer a price concession (see paragraph 606-10-32-7).

Identify the contract with a customer 16

Figure 3.1: Criteria for recognizing a contract

Grant Thornton insight: New guidance may impact existing processes and controls

ASC 606 includes new criteria that must be met before an entity can recognize revenue from a

customer contract. An entity’s business processes and controls might change as a result of

implementing the new guidance. Controls that were designed in response to the revenue recognition

criteria in the legacy revenue guidance may no longer apply. In addition, new controls might be

Can the entity identify each party’s rights regarding the

goods/services to be transferred? (Section 3.1.2)

Consider if the contract meets each of the five criteria

to pass Step 1:

Have the parties approved the contract?

(Section 3.1.1)

Can the entity identify the payment terms for the

goods/services to be transferred? (Section 3.1.3)

Does the contract have commercial substance?

(Section 3.1.4)

Is it probable that the entity will collect substantially all

of the consideration to which it will be entitled in

exchange for the goods/services that will be transferred

to the customer? (Section 3.1.5)

Proceed to Step 2 and only reassess the Step 1 criteria

if there is an indication of a significant change in facts

and circumstances. (Section 3.2.1)

Recognize consideration received

as a liability until each of the five

criteria in Step 1 are met or the

consideration received is

nonrefundable and one of the

following occurs:

1. The entity’s performance is

complete and substantially all of

the consideration has been

collected.

2. The contract has been

terminated.

3. The entity has transferred

control of the goods/services to

which the consideration

received relates, has stopped

transferring goods/services to

the customer, and has no

obligation to transfer additional

goods/services. (Section 3.2)

Continue to assess the contract to

determine if the Step 1 criteria are

met.

Identify the contract with a customer 17

needed, or existing controls might need to be modified, to ensure that an entity’s controls are

effectively designed to address the accounting criteria in ASC 606.

In our experience, many entities’ existing control environments include contract review controls, such

as a contract review template or checklist. The criteria evaluated in these or other review activities will

likely change as entities implement the new revenue standard. For example, if an entity is likely to

grant a customer a price concession, revenue may be recognized earlier under ASC 606 than under

the legacy guidance, since the requirement that the amount of consideration must be fixed or

determinable no longer applies. As a result, the adoption of ASC 606 may cause an entity that is likely

to grant a customer a price concession to evaluate earlier in the contract lifecycle whether revenue

may be recognized and may also result in additional policies, procedures, and controls to account for a

concession as variable consideration, whereas previously the entity may have waited until the contract

price was fixed or determinable to recognize revenue under ASC 605.

Further, the new standard is principles-based and will require management to use judgment in many

areas. As a result, entities should carefully evaluate where additional training, new policies or

procedures, or control activities are needed to ensure that controls are effectively designed.

The parties have approved the contract and are committed to perform

To pass Step 1, the parties must approve the contract. This approval may be written, oral, or implied, as

long as the parties intend to be bound by the terms and conditions of the contract.

The parties should also be committed to performing their respective obligations under the contract. This

does not mean that the parties need to be committed to fulfill all of their respective rights and obligations

in order for this criterion to be met. For example, an entity may include a requirement in a contract for the

customer to purchase a minimum quantity of goods each month, but the entity may have a history of not

enforcing the requirement. In this example, the contract approval criterion can still be satisfied if evidence

supports that the customer and the entity are both substantially committed to the contract. The FASB and

IASB noted

that requiring all of the 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.

At the crossroads: Persuasive evidence of an arrangement under SAB Topic 13 versus

ASC 606 criteria

In accordance with SEC Staff Accounting Bulletin (SAB) Topic 13, revenue is generally earned and

realized (or realizable) when all of the following criteria are met:

• Persuasive evidence of an arrangement exists.

• Delivery has occurred or services have been rendered.

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

• Collectibility is reasonably assured.

BC36, ASU 2014-09.

Identify the contract with a customer 18

The requirement under legacy GAAP that “persuasive evidence of an arrangement exists” is essentially

being replaced by several criteria in ASC 606-10-25-1, including the requirements that the parties have

approved the contract and are committed to perform, the entity can identify each party’s rights

regarding the goods or services to be transferred, and the entity can identify the payment terms for the

goods or services to be transferred.

“Persuasive evidence” under SAB Topic 13 was dictated by an entity’s customary business practices,

which may vary among entities. This requirement is similar to the criterion in ASC 606 that the parties

have approved the contract and are committed to perform. In addition, an entity’s customary practices

may vary by the type of customer or by the nature of the product delivered or services rendered.

Like under SAB Topic 13, an entity applying ASC 606 should carefully consider the existence of side

agreements. A side agreement may call into question whether the original agreement is final and

contains all rights and obligations of the parties.

Some entities offer free trial periods to prospective customers to entice business. These trial periods must

be carefully evaluated to determine if evidence exists to support that the customer has approved the

contract and is committed to perform.

Evaluating trial periods

Members of a wine club receive a bottle of wine each month for 12 months for $20 per month. The wine

vendor is offering a promotional trial period to prospective customers starting January 1, 2018. Under

the terms of the promotion, the vendor offers new participants up to a free two-month trial period. If

participants wish to join the club, they must notify the vendor any time before the trial period lapses

(February 28, 2018). Participants that join the club receive an invoice for the 12-month membership

period, which will end February 28, 2019.

Until the customer gives notice to the wine vendor of its acceptance of the offer (either orally or written),

the entity might not conclude that the customer has approved the contract and is committed to perform.

The entity can identify each party’s rights

An entity must be able to identify its rights, as well as the rights of all other parties to the contract. An

entity cannot assess the transfer of goods or services if it cannot identify each party’s rights regarding

those goods or services.

An entity may utilize a master service arrangement or master supply arrangement (MSA) with its

customers. Each MSA must be evaluated to determine if the MSA alone establishes enforceable rights

and obligations.

The MSA may establish only basic terms and conditions with customers and the entity may require its

customers to also submit purchase orders specifying quantify and/or type of goods or services. In such

cases, the MSA alone may not establish enforceable rights and obligations of the parties. Assuming all of

the other criteria in ASC 606-10-25-1 are met, the MSA might not pass Step 1, and a contract might not

exist, until a purchase order is submitted and approved. Often this will lead to each purchase order being

a contract, depending on facts and circumstances.

Identify the contract with a customer 19

An MSA that specifies minimum purchase quantities may create enforceable rights and obligations;

however, if the entity has a past practice of waiving the minimum purchase requirement and such practice

would render the term legally unenforceable, then the term is not considered when determining if the

MSA alone creates legally enforceable rights and obligations.

The entity can identify the payment terms for the goods or services

An entity must also be able to identify the payment terms for the promised goods or services within the

contract. The entity cannot determine how much it will receive in exchange for the promised goods or

services (the “transaction price” in Step 3 of the model) if it cannot identify the contractual payment terms.

At the crossroads: Fixed or determinable under SAB Topic 13

Unlike the SAB Topic 13 requirement that the payment be “fixed or determinable,” under ASC 606, the

payment need not be fixed; however, the contract must include enough information for the entity to

estimate the amount of consideration that it expects to be entitled to.

The contract has commercial substance

A contract has commercial substance if the risk, timing, or amount of the entity’s cash flows is expected to

change as a result of the contract. In other words, the contract must have economic consequences. This

criterion was added to prevent entities from transferring goods or services back and forth to each other for

little or no consideration to artificially inflate their revenue. This criterion is applicable for both monetary

and nonmonetary transactions, because without commercial substance, it is questionable whether an

entity has entered into a transaction that has economic consequences.

It is probable the entity will collect substantially all of the consideration

To pass Step 1, an entity must determine that it is probable that it will collect substantially all of the

consideration to which it will be entitled under the contract in exchange for goods or services that it will

transfer to the customer. This criterion is also referred to as the “collectibility assessment.” In determining

whether collection is probable, the entity considers the customer’s ability and intention to pay when

amounts are due.

The objective of the collectibility assessment is to evaluate whether there is a substantive transaction

between the entity and the customer. When evaluating collectibility, an entity bases its assessment on

whether the customer has the ability and intention to pay the promised consideration in exchange for the

goods or services that will be transferred under the contract, rather than assessing the collectibility of the

consideration promised for all of the promised goods or services.

Probable: The future event or events are likely to occur.

Identify the contract with a customer 20

ASC 606-10-55-3A

Paragraph 606-10-25-1(e) requires an entity to assess whether it is 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. The assessment, which is part of identifying whether there is a

contract with a customer, is based on whether the customer has the ability and intention to pay the

consideration to which the entity will be entitled in exchange for the goods or services that will be

transferred to the customer. The objective of this assessment is to evaluate whether there is a

substantive transaction between the entity and the customer, which is a necessary condition for the

contract to be accounted for under the revenue model in this Topic.

ASC 606-10-55-3B

The collectibility assessment in paragraph 606-10-25-1(e) is partly a forward-looking assessment. It

requires an entity to use judgment and consider all of the facts and circumstances, including the

entity’s customary business practices and its knowledge of the customer, in determining whether it is

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 the entity expects to transfer to the customer. The assessment

is not necessarily based on the customer’s ability and intention to pay the entire amount of promised

consideration for the entire duration of the contract.

An entity should determine whether the contractual terms and its customary business practices indicate

that it has the ability and intent to mitigate credit risk. For example, some contracts may require upfront

payments before any goods or services are transferred to the customer. Any consideration received

before the entity transfers the goods or services would not be subject to credit risk. In other cases, such

as a telecom providing wireless network access to a building, the entity may be able to stop transferring

goods or services under the contract upon a customer’s failure to pay. In that situation, the entity would

consider the likelihood of payment for only the promised goods or services that will be transferred to the

customer.

An entity is precluded from considering its ability to repossess an asset transferred to a customer when

assessing collectibility.

ASC 606-10-55-3C

When assessing whether a contract meets the criterion in paragraph 606-10-25-1(e), an entity should

determine whether the contractual terms and its customary business practices indicate that the entity’s

exposure to credit risk is less than the entire consideration promised in the contract because the entity

has the ability to mitigate its credit risk. Examples of contractual terms or customary business practices

that might mitigate the entity’s credit risk include the following:

a. Payment terms—In some contracts, payment terms limit an entity’s exposure to credit risk. For

example, a customer may be required to pay a portion of the consideration promised in the

contract before the entity transfers promised goods or services to the customer. In those cases,

any consideration that will be received before the entity transfers promised goods or services to the

customer would not be subject to credit risk.

b. The ability to stop transferring promised goods or services—An entity may limit its exposure to

credit risk if it has the right to stop transferring additional goods or services to a customer in the

Identify the contract with a customer 21

event that the customer fails to pay consideration when it is due. In those cases, an entity should

assess only the collectibility of the consideration to which it will be entitled in exchange for the

goods or services that will be transferred to the customer on the basis of the entity’s rights and

customary business practices. Therefore, if the customer fails to perform as promised and,

consequently, the entity would respond to the customer’s failure to perform by not transferring

additional goods or services to the customer, the entity would not consider the likelihood of

payment for the promised goods or services that will not be transferred under the contract.

An entity’s ability to repossess an asset transferred to a customer should not be considered for the

purpose of assessing the entity’s ability to mitigate its exposure to credit risk.

The following examples from ASC 606 illustrate the guidance on assessing credit risk and the collectibility

criterion.

Example 1—Collectibility of the Consideration; Case B—Credit Risk is Mitigated

ASC 606-10-55-98A

An entity, a service provider, enters into a three-year service contract with a new customer of low credit

quality at the beginning of a calendar month.

ASC 606-10-55-98B

The transaction price of the contract is $720, and $20 is due at the end of each month. The standalone

selling price of the monthly service is $20. Both parties are subject to termination penalties if the

contract is cancelled.

ASC 606-10-55-98C

The entity’s history with this class of customer indicates that while the entity cannot conclude it is

probable the customer will pay the transaction price of $720, the customer is expected to make the

payments required under the contract for at least 9 months. If, during the contract term, the customer

stops making the required payments, the entity’s customary business practice is to limit its credit risk by

not transferring further services to the customer and to pursue collection for the unpaid services.

ASC 606-10-55-98D

In assessing whether the contract meets the criteria in paragraph 606-10-25-1, the entity assesses

whether it is probable that the entity will collect substantially all of the consideration to which it will be

entitled in exchange for the service that will be transferred to the customer. This includes assessing the

entity’s history with this class of customer in accordance with paragraph 606-10-55-3B and its business

practice of stopping service in response to customer nonpayment in accordance with paragraph 606-

10-55-3C. Consequently, as a part of this analysis, the entity does not consider the likelihood of

payment for services that would not be provided in the event of the customer’s nonpayment because

the entity is not exposed to credit risk for those services.

ASC 606-10-55-98E

It is not probable that the entity will collect the entire transaction price ($720) because of the customer’s

low credit rating. However, the entity’s exposure to credit risk is mitigated because the entity has the

ability and intention (as evidenced by its customary business practice) to stop providing services if the

Identify the contract with a customer 22

customer does not pay the promised consideration for services provided when it is due. Therefore, the

entity concludes that the contract meets the criterion in paragraph 606-10-25-1(e) because it is

probable that the customer will pay substantially all of the consideration to which the entity is entitled

for the services the entity will transfer to the customer (that is, for the services the entity will provide for

as long as the customer continues to pay for the services provided). Consequently, assuming the

criteria in paragraph 606-10-25-1(a) through (d) are met, the entity would apply the remaining guidance

in this Topic to recognize revenue and only reassess the criteria in paragraph 606-10-25-1 if there is an

indication of a significant change in facts or circumstances such as the customer not making its

required payments.

Example 1—Collectibility of the Consideration; Case C—Credit Risk is Not Mitigated

ASC 606-10-55-98F

The same facts as in Case B apply to Case C, except that the entity’s history with this class of

customer indicates that there is a risk that the customer will not pay substantially all of the

consideration for services received from the entity, including the risk that the entity will never receive

any payment for any services provided.

ASC 606-10-55-98G

In assessing whether the contract with the customer meets the criteria in 606-10-25-1, the entity

assesses whether it is probable that it 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. This includes

assessing the entity’s history with this class of customer and its business practice of stopping service in

response to the customer’s nonpayment in accordance with paragraph 606-10-55-3C.

ASC 606-10-55-98H

At contract inception, the entity concludes that the criterion in paragraph 606-10-25-1(e) is not met

because it is not probable that the customer will pay substantially all of the consideration to which the

entity will be entitled under the contract for the services that will be transferred to the customer. The

entity concludes that not only is there a risk that the customer will not pay for services received from

the entity, but also there is a risk that the entity will never receive any payment for any services

provided. Subsequently, when the customer initially pays for one month of service, the entity accounts

for the consideration received in accordance with 606-10-25-7 through 25-8. The entity concludes that

none of the events in paragraph 606-10-25-7 have occurred because the contract has not been

terminated, the entity has not received substantially all of the consideration promised in the contract,

and the entity is continuing to provide services to the customer.

ASC 606-10-55-98I

Assume that the customer has made timely payments for several months. In accordance with

paragraph 606-10-25-6, the entity assesses the contract to determine whether the criteria in paragraph

606-10-25-1 are subsequently met. In making that evaluation, the entity considers, among other things,

its experience with this specific customer. On the basis of the customer’s performance under the

contract, the entity concludes that the criteria in 606-10-25-1 have been met, including the collectibility

criterion in paragraph 606-10-25-1(e). Once the criteria in paragraph 606-10-25-1 are met, the entity

applies the remaining guidance in this Topic to recognize revenue.

Identify the contract with a customer 23

At the crossroads: How does the collectibility assessment differ under SAB Topic 13

versus ASC 606?

The new guidance regarding collectibility is somewhat similar to that under SAB Topic 13, which states

that collectibility must be “reasonably assured” before revenue is recognized. However, under SAB

Topic 13, an entity evaluates collectibility when revenue is recognized, while under ASC 606, an entity

evaluates collectibility in Step 1 when it determines whether an accounting contract exists.

Another significant difference is that SAB Topic 13 requires that the entire contract price be reasonably

assured before an entity can recognize revenue, while under ASC 606, an entity does not apply the

concept of collectibility to the portion of the contract for which the entity will not transfer goods or

services (for example, in the event that the customer stops paying).

ASC 606 specifies a sequence and an entity must conclude in Step 1 that collectibility is probable

before proceeding to Step 2 (or Steps 3 through 5).

Another difference from SAB Topic 13 is that ASC 606 explicitly requires an entity to consider whether

the transaction price is variable (see Section 5.1) because the entity may offer the customer a price

concession before determining that collectibility is probable.

Portfolio considerations when assessing collectibility

The TRG has discussed stakeholder questions that have arisen with respect to assessing collectibility

when an entity elects to account for its contracts on a portfolio basis, as described in Section 3.4.

TRG area of general agreement: How should an entity assess collectibility for

a portfolio of contracts?

At its January 2015 meeting,

the TRG discussed how an entity should assess collectibility at contract

inception when the entity has historical experience that indicates it will not collect consideration from

some customers in a portfolio of contracts.

For example, ABC Corp. has a large number of similar customer contracts for which it bills on a

monthly basis in arrears. ABC Corp. performs credit assessment procedures before accepting a

customer. When these procedures result in the conclusion that it is not probable the customer will pay

the amounts owed, the entity does not accept the customer. Because these procedures are only

designed to determine whether collection is probable (and thus not a certainty), the entity anticipates

that it will have some customers that will not pay all amounts owed. Historical evidence, which is

representative of its expectations for the future, indicates that the entity will only collect 98 percent of

the amounts billed.

TRG members agreed that if an entity considers collectibility of the transaction price to be probable for

a portfolio of contracts, then the entity should recognize revenue in full and perform a separate

evaluation of the receivable for impairment. For example, if an entity bills $100 to its customers in a

particular month and expects bad debt expense of $2, the entity should recognize revenue of $100 and

TRG Paper 13, Collectibility.

Identify the contract with a customer 24

a corresponding receivable representing its right to consideration that is unconditional when the entity

satisfies its performance obligations. The guidance does not support the view that only $98 of revenue

should be recognized in this example, because the entity evaluated collectibility for each customer and

concluded that it is probable that each customer will pay the amount to which the entity will be entitled

for a total of $100.

The resultant contract asset or receivable should be assessed for impairment under the receivable

guidance in ASC 310. An entity would recognize the difference between the measurement of the

receivable and the corresponding revenue as bad debt expense.

Price concessions

In determining the “consideration to which an entity will be entitled” for purposes of the collectibility

assessment, an entity needs to evaluate at contract inception whether it expects to provide a price

concession that will result in receiving less than the full contract price from the customer. Although price

concessions are a form of variable consideration and are more fully evaluated when determining the

transaction price under Step 3 (Section 5.1), when evaluating collectibility under Step 1, an entity should

also assess at the onset of an arrangement whether it expects to provide a price concession.

When an entity expects to accept less than the contractual amount for goods and services that will be

transferred to the customer, it should evaluate all relevant facts and circumstances, which may require

significant judgment, to determine whether it has accepted a customer’s credit risk or has provided an

implicit price concession.

Example 2—Consideration is Not the Stated Price—Implicit Price Concession

ASC 606-10-55-99

An entity sells 1,000 units of a prescription drug to a customer for promised consideration of $1 million.

This is the entity’s first sale to a customer in a new region, which is experiencing significant economic

difficulty. Thus, the entity expects that it will not be able to collect from the customer the full amount of

the promised consideration. Despite the possibility of not collecting the full amount, the entity expects

the region’s economy to recover over the next two to three years and determines that a relationship

with the customer could help it to forge relationships with other potential customers in the region.

ASC 606-10-55-100

When assessing whether the criterion in paragraph 606-10-25-1(e) is met, the entity also considers

paragraph 606-10-32-2 and 606-10-32-7(b). Based on the assessment of the facts and circumstances,

the entity determines that it expects to provide a price concession and accept a lower amount of

consideration from the customer. Accordingly, the entity concludes that the transaction price is not

$1 million and, therefore, the promised consideration is variable. The entity estimates the variable

consideration and determines that it expects to be entitled to $400,000.

ASC 606-10-55-101

The entity considers the customer’s ability and intention to pay the consideration and concludes that

even though the region is experiencing economic difficulty it is probable that it will collect $400,000

from the customer. Consequently, the entity concludes that the criterion in paragraph 606-10-25-1(e) is

met based on an estimate of variable consideration of $400,000. In addition, based on an evaluation of

Identify the contract with a customer 25

the contract terms and other facts and circumstances, the entity concludes that the other criteria in

paragraph 606-10-25-1 are also met. Consequently, the entity accounts for the contract with the

customer in accordance with the guidance in this Topic.

It can sometimes be difficult to distinguish between a price concession and a collectibility issue. The

ramifications could impact the accounting because one path (a collectibility concern) might lead an entity

to conclude that it does not pass Step 1 for a particular arrangement, while another path (a price

concession) may result in variable consideration and allow the entity to proceed to Step 2 with a lower

transaction price. Judgment will be required to determine which path is appropriate. Ultimately, as

discussed by the TRG,

this is not a new area of judgment.

Grant Thornton insight: Price concession versus collectibility issue

ASC 606-10-32-7 provides guidance on factors an entity considers to determine if the promised

consideration is variable because it has offered, or expects to offer, a price concession. It states, in

part, that a price concession exists if either of the following conditions is met:

a. 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 price stated in the contract. That is, it is expected that the entity will offer a price

concession.

b. Other facts and circumstances indicate that the entity’s intention, when entering into the contract

with the customer, is to offer a price concession to the customer.

Other possible indicators that suggest an entity is offering a price concession include

• A business practice of not performing a credit assessment prior to transferring promised goods or

services (for example, a health care provider that is required by law to perform, as described in

ASC 606-10-55-102 through 55-106, Example 3)

• A valid expectation of the customer that the entity will accept less than the contractually stated

amount

• A business practice of continuing to perform despite historical experience suggesting that

collection is not probable

• An arrangement where there is little to no incremental cost associated with fulfilling the

performance obligations (for example, a software provider that incurs little to no reproduction cost

when selling licenses for an existing software product)

• An expectation by the entity at the onset of the arrangement that despite pricing in the contract it

later will offer a price concession (for example, the entity will accept less than the stated price in

order to develop a strategic relationship with a new customer)

Factors that may indicate a customer or pool of customers presents collectibility issues include

• The customer’s financial condition has deteriorated since contract inception.

TRG Paper 13, Collectibility.

Identify the contract with a customer 26

• The entity has a pool (portfolio) of homogeneous customers with similar credit profiles, and while it

expects that most will pay amounts when due, it expects that some will not.

There may be other relevant indicators, depending on the facts and circumstances.

See further guidance regarding price concessions, including estimating and reassessing the amount of

variable consideration, at Section 5.1.

3.2 Contracts that do not ‘pass’ Step 1

If an entity determines at an arrangement’s inception that one or more of the criteria in ASC 606-10-25-1

have not been met, an accounting contract, for purposes of applying ASC 606, does not exist, and the

entity should continue to reassess whether the five criteria are subsequently met.

A contract may not pass Step 1, but the entity may still transfer goods or services to the customer and

receive nonrefundable consideration in exchange for those goods or services. In that circumstance, the

entity cannot recognize revenue for the nonrefundable consideration received until either the Step 1

criteria are subsequently met, or one of the events outlined in ASC 606-10-25-7 has occurred, as

discussed below.

ASC 606-10-25-7

When a contract with a customer does not meet the criteria in paragraph 606-10-25-1 and an entity

receives consideration from the customer, the entity shall recognize the consideration received as

revenue only when one or more of the following events have occurred:

a. The entity has no remaining obligations to transfer goods or services to the customer, and all, or

substantially all, of the consideration promised by the customer has been received by the entity and

is nonrefundable.

b. The contract has been terminated, and the consideration received from the customer is

nonrefundable.

c. 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.

The third criterion was added by the FASB

to accommodate situations in which an entity has not legally

terminated the contract because it wants to continue to pursue collection or its other rights under the

contract.

BC23 and BC24, ASU 2016-12.

Identify the contract with a customer 27

Until the contract passes Step 1 or one of the above criteria is met, an entity should recognize the

consideration received from a customer as a liability that is measured at the amount of consideration

received from the customer.

Figure 3.2: When cash is received for a contract that does not pass Step 1

At the crossroads: Not cash basis accounting

In some circumstances, the guidance on accounting for contracts when the criteria in ASC 606-10-

25-1 are not met may result in a delay in recognizing revenue compared to the guidance under

legacy GAAP. For example, under ASC 606, if a contract does not meet one of the criteria in

ASC 606-10-25-7, an entity is required to recognize a liability for nonrefundable amounts received

in an arrangement when performance under the contract is not complete. In contrast, under legacy

GAAP, an entity may have recognized revenue in the amount of cash received for goods or services

that have been transferred.

The FASB noted

that ASC 606-10-25-7(c) is not equivalent to a “cash basis” of accounting under

legacy GAAP because in order to meet this new criterion, the entity must either stop transferring goods

BC24, ASU 2016-12.

Is the cash received nonrefundable?

Has the entity completed performance under

the contract and received all (or substantially

all) amounts from the customer?

Has the arrangement been terminated?

Are all of the following criteria met?

• The entity has transferred control of

the goods or services to which the

consideration received relates.

• The entity has stopped transferring

goods or services to the customer.

•

The entity has no obligation to transfer

additional goods or service.

Recognize

revenue in the

amount of

nonrefundable

consideration

received.

Recognize the

consideration

received as

a liability.

Identify the contract with a customer 28

or services to the customer, with no obligation to transfer additional goods or services to the customer,

or not have any additional promised goods or services to transfer.

Reassessing the Step 1 criteria

When an entity determines that a contract passes Step 1, it should not reassess contract existence

unless there is an indication of a significant change in facts and circumstances.

ASC 606-10-25-5

If a contract with a customer meets the criteria in paragraph 606-10-25-1 at contract inception, an entity

shall not reassess those criteria unless there is an indication of a significant change in facts and

circumstances. For example, if a customer’s ability to pay the consideration deteriorates significantly,

an entity would 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 (see paragraphs 606-10-55-3A through 55-3C).

Grant Thornton insight: When a contract ‘passes’ Step 1, what constitutes a ‘significant

change in facts and circumstances’ necessitating a reassessment in the Step 1

criteria?

The determination of what constitutes a “significant change in facts and circumstances” will often

require judgment. Continuing with the example in ASC 606-10-25-5, if the entity determines that it is no

longer probable that it will collect the consideration, the entity would not recognize revenue for the

remaining goods and services as they are transferred to the customer, and would instead apply the

guidance in ASC 606-10-25-7.

Example 4 in ASC 606 illustrates the guidance on reassessing the criteria for identifying a contract.

Example 4—Reassessing the Criteria for Identifying a Contract

ASC 606-10-55-106

An entity licenses a patent to a customer in exchange for a usage-based royalty. At contract inception,

the contract meets all the criteria in paragraph 606-10-25-1, and the entity accounts for the contract

with the customer in accordance with the guidance in this Topic. The entity recognizes revenue when

the customer’s subsequent usage occurs in accordance with paragraph 606-10-55-65.

ASC 606-10-55-107

Throughout the first year of the contract, the customer provides quarterly reports of usage and pays

within the agreed-upon period.

Identify the contract with a customer 29

ASC 606-10-55-108

During the second year of the contract, the customer continues to use the entity’s patent, but the

customer’s financial condition declines. The customer’s current access to credit and available cash on

hand are limited. The entity continues to recognize revenue on the basis of the customer’s usage

throughout the second year. The customer pays the first quarter’s royalties but makes nominal

payments for the usage of the patent in quarters 2–4. The entity accounts for any impairment of the

existing receivable in accordance with Topic 310 on receivables.

ASC 606-10-55-109

During the third year of the contract, the customer continues to use the entity’s patent. However, the

entity learns that the customer has lost access to credit and its major customers and thus the

customer’s ability to pay significantly deteriorates. The entity therefore concludes that it is unlikely that

the customer will be able to make any further royalty payments for ongoing usage of the entity’s patent.

As a result of this significant change in facts and circumstances, in accordance with paragraph 606-10-

25-5, the entity reassesses the criteria in paragraph 606-10-25-1 and determines that they are not met

because it is no longer probable that the entity will collect the consideration to which it will be entitled.

Accordingly, the entity does not recognize any further revenue associated with the customer’s future

usage of its patent. The entity accounts for any impairment of the existing receivable in accordance

with Topic 310 on receivables.

Pending Content

Transition Date: (P) December 16, 2019; (N) December 16, 2020 | Transition Guidance:

326-20-65-1

ASC 606-10-55-108

… The entity accounts for any credit losses on the existing receivable in accordance with

Subtopic 326-20 on financial instruments measured at amortized cost.

ASC 606-10-55-109

… The entity accounts for additional credit losses on the existing receivable in accordance with

Subtopic 326-20.

When the entity concludes that collectibility is no longer probable, only the revenue related to the

remaining goods or services yet to be transferred is impacted. Other than impairment considerations, the

reassessment has no impact on revenue recognized to date, receivables recorded, or assets recognized

as a result of satisfied performance obligations.

Identify the contract with a customer 30

TRG area of general agreement: Reassessing collectibility

The TRG discussed at its January 2015 meeting

when an entity should reassess collectibility for a

customer after concluding that the customer passes Step 1 at the inception of a multi-year contract.

The TRG considered Example 4 above, whereby an entity licenses a patent to a customer in exchange

for a usage-based royalty.

The TRG agreed that Example 4 demonstrates that

• The determination of whether there is a significant change in facts or circumstances will be

situation-specific and will require judgment.

• The change in the customer’s financial condition is so significant that it is an indication that the

contract is no longer valid and fails Step 1 from that point forward.

3.3 Contract term

An entity applies ASC 606 to the contractual period over which the parties to the contract have present

enforceable rights and obligations. Enforceability of the rights and obligations is a matter of law. Because

practices and processes for establishing contracts with customers may vary across jurisdictions and

entities, each entity should consider its established practices and processes when determining whether

its agreements create enforceable rights and obligations.

Termination provisions

Some contracts can be terminated by either party at any time while others may only be terminated by one

party. An accounting contract does not exist if each party to a contract has the unilateral enforceable right

to terminate a wholly unperformed contract without paying a termination penalty. A “wholly unperformed”

contract means that the entity hasn’t yet performed and is not entitled to any consideration.

ASC 606-10-25-3 (excerpt)

Some contracts with customers may have no fixed duration and can be terminated or modified by

either party at any time. Other contracts may automatically renew on a periodic basis that is specified

in the contract. An entity shall apply the guidance in this Topic to the duration of the contract (that is,

the contractual period) in which the parties to the contract have present enforceable rights and

obligations.

ASC 606-10-25-4

For the purpose of applying the guidance in this Topic, a contract does not exist if each party to the

contract has the unilateral enforceable right to terminate a wholly unperformed contract without

compensating the other party (or parties). A contract is wholly unperformed if both of the following

criteria are met:

a. The entity has not yet transferred any promised goods or services to the customer.

TRG Paper 13, Collectibility.

Identify the contract with a customer 31

b. The entity has not yet received, and is not yet entitled to receive, any consideration in exchange for

promised goods or services.

Contract cancellable for a full refund

On March 15, a customer orders a standard piece of furniture from a retailer and pays $1,000 for the

furniture in advance of delivery, which typically occurs within 30 days. The contract indicates that the

customer can cancel the order at any time prior to delivery and receive a full refund of the advance

payment; however, the retailer has no cancellation rights.

The retailer considers whether it has a contract with a customer that passes Step 1 on March 15. When

the customer paid for the furniture in advance, the contract was no longer wholly unperformed because

the retailer had received consideration. Therefore, the guidance regarding wholly unperformed contracts

in ASC 606-10-25-4 does not apply.

The retailer determines that a contract exists on March 15 because the contract meets the five criteria

under Step 1 of the revenue recognition model:

• Both parties have approved the contract and are committed to performing their obligations as

indicated by their signing the sales order and further supported by the $1,000 advance payment.

• Both parties’ rights are identifiable in the contract terms.

• The payment terms are identified in the contract.

• The contract has commercial substance as the amount of the entity’s future cash flow is expected to

change as a result of the contract.

• Collectibility is probable since it has already occurred.

In some situations, only the customer has the ability to terminate the contract without penalty. In those

situations, the contract term for accounting purposes may be shorter than the stated contract term.

Ability to terminate without penalty

A tennis club enters into a contract with a new member to provide access to its tennis courts for a

12-month period at $100 per month. The member can cancel his or her membership without penalty

after six months. The enforceable rights and obligations of this contract are for six months, and therefore

the contract term is six months.

The TRG has discussed how a termination penalty may impact the contract term, as summarized below.

Identify the contract with a customer 32

TRG area of general agreement: How should termination clauses be evaluated in

determining the duration of a contract?

The TRG discussed the accounting for termination clauses at its October 2014 meeting.

During this

meeting, the TRG specifically discussed fact patterns when each party to the contract has the unilateral

right to terminate the contract by paying a termination penalty. TRG members agreed the contract

exists throughout the period covered by the termination penalties because the penalties are evidence

of enforceable rights and obligations throughout the term of the contract. That said, the mere existence

of a penalty by itself would not mean that the contract term includes the periods covered by the

penalties. The penalties must be substantive.

At its November 2015 meeting,

the TRG also agreed that the discussion from October 2014

summarized above applies to contracts in which only the customer has a unilateral ability to terminate

the contract. This is because the change in the fact pattern is not significant enough to warrant a

different view. Therefore, in contracts where only the customer has a unilateral ability to terminate the

contact, a contract exists throughout the period covered by the termination penalty as long as the

penalty is substantive.

A common business model for some entities is to sell goods at a loss and to make money through sales

of consumables that the customer has to purchase again and again (for example, a razor and razor

blades, or a printer and printer cartridges). Sometimes these contracts are structured in such a way that if

the customer does not purchase a minimum amount of consumables, it must pay a termination penalty.

The TRG discussed how these contracts may effectively include a substantive termination penalty, which

creates enforceable rights and obligations that may impact the contract term.

TRG area of general agreement: How should an entity evaluate the contract term when

only the customer has the right to cancel without cause, and how do termination

penalties affect that analysis?

At its November 2015 meeting,

the TRG discussed a scenario where only one party has the

termination right. The TRG considered a contract for equipment and consumable parts in which the

standalone selling price of the equipment and parts is $10,000 and $100, respectively. The entity sells

the equipment for $6,000 and provides the customer with an option to purchase each part for $100. If

the customer does not purchase at least 200 parts, it must pay a penalty that repays some or all of the

$4,000 discount, and that penalty decreases as each part is purchased at a rate of $20 per part. The

example assumes that the equipment and consumables are distinct goods, revenue is recognized at a

point in time, and a discount of $10 would be a material right to the customer.

The TRG generally agreed that substantive termination penalties create enforceable rights and

obligations, effectively creating a minimum purchase obligation for 200 parts in the example above.

The TRG debated what constitutes a “substantive” penalty and acknowledged that significant judgment

would be required to make that determination. One consideration in assessing whether a penalty is

TRG Paper 10, Contract enforceability and termination clauses.

TRG Paper 48, Customer options for additional goods and services.

Ibid.

Identify the contract with a customer 33

substantive would be to evaluate how many customers opt to pay the penalty. A significant number of

customers opting to pay the penalty might indicate that the penalty is not substantive. If the penalty is

not substantive, the entity must still evaluate whether the termination right (which is similar to an option

for additional goods or services) gives rise to a material right. Said differently, if the existence of a

contractual penalty does not create a longer contract term, it still could impact whether a material right

is present for the optional goods or services.

At a separate meeting, the TRG discussed whether an entity’s past practice of waiving termination

penalties would impact the assessment of the contract term and generally agreed that the answer

depends on whether the past practice changes the legally enforceable rights and obligations, as

explained below.

TRG area of general agreement: When an entity has a past practice of not enforcing the

collection of termination penalties, does the past practice affect the assessment of the

contract term?

At its October 2014 meeting,

the TRG discussed a fact pattern whereby an entity enters into a

contract to provide services for 24 months. Either party can terminate the contract by compensating the

other party. The entity has a past practice of not enforcing collection of the termination penalty when

customers cancel after at least 12 months.

The TRG agreed that the determination of whether the contractual period is 24 months or 12 months

depends on whether the past practice legally restricts the enforceable rights and obligations of the

parties, which may vary by jurisdiction. The entity’s past practice would affect the contract term only if

that past 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

24 months.

3.4 Portfolio practical expedient

The guidance in ASC 606 applies to an individual contract with a customer but allows entities to apply the

guidance to a portfolio of contracts or performance obligations with similar characteristics as a practical

expedient. However, an entity may apply the practical expedient only if it expects that the effects of

applying the guidance on a portfolio basis would not differ materially from applying the guidance on an

individual contract-by-contract basis.

An entity will need to exercise judgment to determine how to group particular contracts or performance

obligations for purposes of applying the portfolio practical expedient.

TRG Paper 10, Contract enforceability and termination clauses.

Identify the contract with a customer 34

ASC 606-10-10-4

This guidance specifies the accounting for an individual contract with a customer. However, as a

practical expedient, an entity may apply this guidance 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 this guidance to the portfolio would not differ materially from applying this

guidance to the individual contracts (or performance obligations) within that portfolio. When accounting

for a portfolio, an entity shall use estimates and assumptions that reflect the size and composition of

the portfolio.

TRG area of general agreement: Is an entity applying the portfolio practical expedient

when it considers evidence from other, similar contracts to develop an estimate using

the expected value method?

At its July 2015 meeting,

the TRG generally agreed that an entity can consider evidence from other,

similar contracts to develop an estimate of variable consideration using the expected value method

without applying the portfolio practical expedient. Said differently, considering historical experience

does not necessarily mean that the entity is applying the portfolio practical expedient. This view is

further supported by the guidance on estimating the standalone selling price of a good or service.

ASC 606-10-32-34(a) states that a suitable method for estimating the standalone selling price of a

good or service would include referring to prices of similar goods or services.

Stakeholders have questioned whether an entity needs to “prove” that the effects of applying the portfolio

practical expedient do not differ materially from applying the guidance on an individual contract-by-

contract basis. The Boards indicated in BC69 of ASU 2014-09 that they did not intend for entities to

quantitatively evaluate each outcome and that entities should instead be able to determine a reasonable

expectation that the portfolio approach would not differ materially and therefore determine the portfolios

that would be appropriate for their types of contracts.

Grant Thornton insight: How should an entity evaluate whether contracts have similar

characteristics?

ASC 606 does not include prescriptive guidance on how to determine if contracts may be grouped

within the same portfolio.

An entity will need to exercise judgment to determine which contracts have similar characteristics when

evaluating whether the contracts may be grouped within the same portfolio. One way to categorize

contracts by portfolio may be by contract type. If an entity typically uses standard contract language,

this may indicate that grouping the contracts into a single portfolio may be appropriate.

Another possible way to categorize contracts by portfolio would be by class of customer and the

customer’s behavior pattern. For example, a healthcare entity may have evidence that suggests that

TRG Paper 38, Portfolio Practical Expedient and Application of Variable Consideration Constraint.

Identify the contract with a customer 35

uninsured patients (customers) act similarly while insured patients (customers) act similarly and result

in similar revenue recognition patterns. Additionally, insured patients might fall into different portfolios

based on the terms of their insurance coverage.

Application of the portfolio practical expedient

A retailer sells clothing and shoes online and in brick-and-mortar stores. Based on historical experience,

the retailer determines that online customers return 20 percent of items sold. However, the historical

return rate for in-store sales is lower, at only 3 percent for shoes and 5 percent for clothing.

Because the historical pattern of behavior is different for online versus in-store customers, the retailer

concludes that it would not be appropriate to include both of these classes of customers in the same

portfolio of contracts.

The retailer considers whether in-store sales of clothing and shoes should be in the same portfolio of

contracts because the return rates of 3 percent and 5 percent differ. The retailer determines that the

historic weighted-average return rate for clothing and shoes is closer to 5 percent because more

clothing is sold than shoes. As a result, the retailer includes all in-store sales in the same portfolio of

contracts because the historical return activity from in-store sales is similar for both shoes and clothing

and the use of 5 percent is reasonable.

The retailer enters into 1,000 in-store sales transactions, each for $100. Seven hundred contracts are

for clothing and 300 are for shoes. The retailer applies the 5 percent return rate to the portfolio of in-

store contracts and estimates a return liability of $5,000 (5% x 1,000 contracts x $100).

The retailer reasonably expects that the effect on the financial statements of applying the 5 percent

return rate to the portfolio of in-store contracts would not differ materially from accounting for the

clothing and shoe contracts individually. The retailer periodically estimates the potential difference to the

return liability and revenue as though each in-store contract had been accounted for on an individual

basis in order to ensure the effect on the financial statements of applying the portfolio approach would

not differ materially from accounting for the contracts individually. In this example, the difference could

reasonably be expected to approximate $600, calculated as $5,000 (the refund liability under the

portfolio practical expedient) less $4,400 (the refund liability using the specific return percentages for

clothing and shoes; $4,400 = $3,500 (5% x 700 x $100) + $900 (3% x 300 x $100)) and the retailer

concludes this difference is not material.

The retailer monitors customer behavior, including return rates as well as sales channel and product

mix, on an ongoing basis to continually evaluate whether it is appropriate to apply the portfolio practical

expedient to all in-store sales.

3.5 Combining contracts

An entity should combine two or more contracts and account for them as a single contract in certain

circumstances because the substance of the individual contracts cannot be understood without

considering the entire arrangement. This evaluation takes place at contract inception.

In summary, two or more contracts may need to be accounted for as a single contract if they are entered

into at or near the same time with the same customer (or with related parties), and if one of the following

conditions exists:

Identify the contract with a customer 36

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

• The amount of consideration paid in one contract depends on the price or performance in the other

contract.

• The goods or services promised in the contract are a single performance obligation.

The guidance does not specify what constitutes “at or near the same time,” so an entity will need to

exercise judgment to determine what constitutes this time frame as well as develop processes to evaluate

whether the criteria are met.

ASC 606-10-25-9

An entity shall combine two or more contracts entered into at or near the same time with the same

customer (or related parties of the customer) and account for the contracts as a single contract if one or

more of the following criteria are met:

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

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

other contract.

c. The goods or services promised in the contracts (or some goods or services promised in each of

the contracts) are a single performance obligation in accordance with paragraphs 606-10-25-14

through 25-22.

At the crossroads: Combining contracts under ASC 606 versus legacy GAAP

The guidance in ASC 606 on combining contracts is similar to the guidance in legacy GAAP, except for

one important distinction. Legacy GAAP includes indicators for an entity to consider in evaluating

whether two or more contracts should be combined. In contrast, ASC 606 requires that an entity

combine contracts that were entered into at or near the same time with the same customer (or with

related parties of the customer) if they meet any of the stated criteria. As a result, an entity may need to

combine more contracts and should determine what constitutes “at or near the same time” as well as

develop processes to evaluate whether the criteria are met.

In many situations, the criteria related to whether the performance obligations or payments in multiple

contracts are interdependent will be a straightforward evaluation; however, because ASC 606 is

principle-based, many entities might find that significant judgment is required to determine whether

multiple contracts are negotiated with a single commercial objective in mind or whether the goods

and/or services under those contracts constitute a single performance obligation.

For example, if one contract with a party is for the construction of a building and another contract with

the same party is for the installation of the elevators in that building, careful analysis of both contracts

may lead to the conclusion that there is a single performance obligation for the building and the

contracts therefore should be combined. On the other hand, a contract with a party to construct a

building and a second contract to install elevators at an adjacent property owned by the customer may

require greater effort to determine whether the contracts should be combined.

4. Identify the performance obligations in the contract

Once a contract passes the Step 1 criteria (see Section 3.1), the entity may proceed to Step 2 in the

revenue model. Step 2 is a critical step in the five-step revenue model. In this step, an entity identifies its

performance obligations, which will serve as the unit of account throughout the rest of the model. If an

entity fails to properly identify its performance obligations in Step 2, the subsequent accounting in Step 3

through Step 5 may not be appropriate.

Step 2 is a two-part process. Before an entity can identify its performance obligations, it must first identify

all of the promised goods or services in the contract. Only after an entity identifies its promises can it then

determine which of those promised goods or services constitute performance obligations.

Figure 4.1: Step 2 at a glance

4.1 Identifying promises

Promises are often explicitly specified in a contract but also may be implied by an entity’s customary

business practices, published policies, or specific statements that, at contract inception, create a

reasonable expectation of the customer that the entity will transfer a good or service.

ASC 606-10-25-16

A contract with a customer generally explicitly states the goods or services that an entity promises

to transfer to a customer. However, the promised goods or services identified in a contract with a

customer may not be limited to the goods or services that are explicitly stated in the contract. This

is because a contract with a customer also may include promises that are implied by an entity’s

customary business practices, published policies, or specific statements if, at the time of entering into

the contract, those promises create a reasonable expectation of the customer that the entity will

transfer a good or service to the customer.

ASC 606-10-25-18

Depending on the contract, promised goods or services may include, but are not limited to, the

following:

a. Sale of goods produced by an entity (for example, inventory of a manufacturer)

b. Resale of goods purchased by an entity (for example, merchandise of a retailer)

Identify the promises in the contract

(Section 4.1)

Determine if the promises are separate

performance obligations (Section 4.2)

Identify the performance obligations in the contract 38

c. Resale of rights to goods or services purchased by an entity (for example, a ticket resold by an

entity acting as a principal, as described in paragraphs 606-10-55-36 through 55-40)

d. Performing a contractually agreed-upon task (or tasks) for a customer

e. Providing a service of standing ready to provide goods or services (for example, unspecified

updates to software that are provided on a when-and-if-available basis) or of making goods or

services available for a customer to use as and when the customer decides

f. Providing a service of arranging for another party to transfer goods or services to a customer (for

example, acting as an agent of another party, as described in paragraphs 606-10-55-36 through

55-40)

g. Granting rights to goods or services to be provided in the future that a customer can resell or

provide to its customer (for example, an entity selling a product to a retailer promises to transfer an

additional good or service to an individual who purchases the product from the retailer)

h. Constructing, manufacturing, or developing an asset on behalf of a customer

i. Granting licenses (see paragraphs 606-10-55-54 through 55-60 and paragraphs 606-10-55-62

through 55-65B)

j. Granting options to purchase additional goods or services (when those options provide a customer

with a material right, as described in paragraphs 606-10-55-41 through 55-45)

When identifying promises, an entity should consider the customer’s perspective because contractual

promises are part of the negotiated exchange between the entity and the customer.

Further, implied promises do not need to be enforceable by law. If a customer has a reasonable

expectation that the entity has made a promise, the customer would view the promise as part of the

contract. Absent this guidance on implied promises,

an entity might incorrectly recognize all of the

consideration received, despite having a remaining (implicit) promise to the customer.

BC87, ASU 2014-09.

Identify the performance obligations in the contract 39

Figure 4.2: Examples of promises

Promise

Example

Sales of goods produced

A manufacturing entity sells inventory.

Resale of goods purchased

A retail entity sells purchased merchandise.

Resale of rights to goods or services

purchased by an entity

A hospitality entity that purchased a concert

ticket resells the ticket, acting as principal.

Performing tasks

A professional services entity provides

consulting services.

Providing 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

A manufacturing entity provides maintenance

services on machines sold to a customer when

the customer decides it wants the services

performed.

Providing the service of arranging for another

party to transfer goods or services

A general maintenance entity acting as an agent

provides a service of arranging for an unrelated

party to provide specialized elevator maintenance

to a customer.

Constructing, manufacturing, or developing an

asset

A contractor builds a hospital.

Granting licenses

An entity grants a license to use its trade name.

Granting options to purchase additional goods or

services that create a material right

A retailer grants a customer an option to buy three

items and to receive 60 percent off of a fourth item

at a later date.

Implicit promise of services

Although not explicitly stated in the contract or

discussed in negotiations, a manufacturing entity

has a customary business practice of providing

maintenance services on machines sold to its

customers. This practice creates a reasonable

expectation on the part of the customer that the

entity will perform periodic maintenance.

Administrative services

ASC 606 defines “promises” as those activities that transfer goods or services to the customer. In addition

to the promised goods and services, an entity may be required to perform certain administrative services

in providing the promised goods and services in the contract. As these administrative services typically do

Identify the performance obligations in the contract 40

not transfer a good or service to a customer, they are not considered promises in a contract with a

customer, regardless of whether a payment from the customer is received when those administrative

services are provided. If payment is received for administrative services that do not directly transfer a

good or service to the customer, the payment should be accounted for as part of the transaction price,

which is allocated to the identified performance obligations. When payments for related administrative

services are nonrefundable, the guidance in Section 4.5 should be followed. Entities should also evaluate

the costs incurred in providing the administrative services using the guidance on costs to fulfill a contract

in ASC 340-40, which is further discussed in Section 11.2.

Immaterial promises

When a promise is immaterial in the context of a contract, an entity does not need to assess the promise

to determine if it meets the definition of a performance obligation.

ASC 606-10-25-16A

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. 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 shall be accrued.

The FASB decided

that an entity is required to consider whether a promised good or service is

immaterial only at the contract level (not at the entity level) because it would be unduly burdensome to

require an entity to aggregate and determine the effect on its financial statements of those items or

activities determined to be immaterial at the individual contract level. However, if multiple goods or

services in a single contract are individually immaterial in the context of the contract, but those individually

immaterial items are in the aggregate material to that contract, then an entity should not disregard those

goods or services when identifying performance obligations in the contract.

Grant Thornton insight: Promises that may be immaterial within the context

of the contract

Entities must evaluate whether a promise is immaterial within the context of each individual contract.

As a result, we believe that an entity should not include in its accounting policy a quantitative definition

of immaterial, such as all promises under either a certain dollar amount or percentage threshold. This

evaluation of whether a promise is immaterial within the context of each contract should be performed

based on each individual customer contract, and should not be based on a measure of the company’s

financial statements. An entity should consider both quantitative and qualitative factors in determining

whether a promise is immaterial. Qualitative considerations may include the promise’s relationship to

other promises in the contract and the significance of the promise to the customer’s decision to enter

into the contract.

BC12, ASU 2016-10.

BC14, ASU 2016-10.

Identify the performance obligations in the contract 41

Evaluation of promises that are individually immaterial but in aggregate are material

in the context of the contract

A supplier provides multiple goods to a customer as part of its overall contract, including goods A, B, C,

and D.

The supplier concludes that goods B, C, and D are individually quantitatively immaterial in the context of

the contract; however, those goods are quantitatively material in aggregate. As a result, the supplier

cannot disregard goods B, C, and D when identifying its performance obligations. The supplier should

also evaluate whether goods B, C, and D are qualitatively immaterial.

Determining whether promised goods or services are immaterial in the context of the contract may require

judgment; however, the Board expects that the assessment should be straightforward in many cases

because it should be clear that the item is immaterial when considering the nature of the entity’s

arrangement with the customer.

At the crossroads: Inconsequential and perfunctory versus immaterial promises

One question from stakeholders was whether an entity can continue to apply the “inconsequential or

perfunctory” guidance from SAB Topic 13 to identify immaterial promises.

We believe the answer is no. BC90 of ASU 2014-09 states that the Boards decided not to exempt an

entity from accounting for promised goods or services that the entity might regard as being perfunctory

or inconsequential. Instead, the entity should assess whether those promised goods or services are

immaterial in the context of the contract.

While the end results of applying the guidance in ASC 606 on immaterial promises and the guidance in

SAB Topic 13 may not materially differ, the models do, in fact, differ, and the Boards decided not to

pursue the model under SAB Topic 13.

As such, an entity must apply the guidance in ASC 606 to

determine whether a promised good or service is immaterial in the context of the contract. Further,

ASC 606 includes the requirement, as noted above, that an entity cannot disregard goods or services

that are individually immaterial in the context of the contract but material in aggregate.

Some stakeholders asked if each and every activity performed in satisfying the contract must be a

promised good or service that should be evaluated under the new model. In response, the FASB

clarified in BC11 in ASU 2016-10 that it intended the notion of a “promised good or service” to be

similar to the notion of deliverables, components, or elements of a contract in legacy GAAP. Said

differently, the FASB did not intend for an entity to identify significantly more promised goods and

services that result in performance obligations when applying the new model than it identified under

legacy GAAP. The one exception is certain material rights that are not identified as deliverables under

legacy GAAP but that meet the definition of performance obligations under ASC 606, for example,

credits and points associated with a loyalty program. However, we expect that in certain

BC17, ASU 2016-10.

Identify the performance obligations in the contract 42

circumstances, an entity will identify more performance obligations while in other situations, the entity

will identify fewer performance obligations as compared to legacy GAAP.

BC12 of ASU 2016-10 states, in part, that when determining whether a promise is immaterial in the

context of the contract, an entity should consider the relative significance or importance of a particular

promised good or service in the contract to the arrangement with the customer as a whole, taking into

consideration both the quantitative and qualitative nature of the promised goods or services in the

contract. For example, when evaluating whether a promise is quantitatively immaterial, an entity could

consider, among other factors, the significance of the estimated stand-alone selling price of the promised

item relative to the aggregate stand-alone selling price of all promised goods or services. Similarly, when

evaluating whether a promise is qualitatively immaterial, an entity should consider the customer’s

viewpoint, including factors such as whether the utility or benefit of the promised item is immaterial to the

customer compared to the complete group of goods and services included in the contract.

Evaluation of immaterial promises

A national hotel chain provides hotel rooms to guests that stay at its locations across the United States.

Part of the hotel’s service includes placing two free bottles of water in the room for guests to enjoy. The

hotel also slides a paper statement under guests’ doors the last night of their stay so that they can

review the statement prior to checking out and retain a copy for their records.

When considering the nature of its promise to the customer, the hotel chain concludes that the customer

views the service of providing access to the hotel room as the promise. While the guest may appreciate

the two bottles of free water and the paper statement under the door at the end of the stay, neither

generally would influence a guest’s decision about staying at the hotel. From a quantitative perspective,

the hotel determines the cost of the water to be less than 0.4 percent of the price of the average room

rate ([$0.50 per bottle × 2 bottles] ÷ $250 average price per room).

As a result, the hotel determines that offering the two bottles of water per room as well as the paper

statement are both quantitatively and qualitatively immaterial in the context of the contract and therefore

will not evaluate those promises to determine if they constitute separate performance obligations.

Evaluating promises in a contract to determine if immaterial

Entity A owns and operates a sports stadium, which hosts sporting events and other special events. In

addition to providing events in the stadium, one of Entity A’s ordinary activities is providing marketing

services to customers at the sports stadium—for example, on billboards and on electronic devices

throughout the stadium. Entity A enters into a contract with its customer, Entity B, for marketing

services. The contract includes a promise for Entity A to provide Entity B with tickets to each event held

at the stadium. Entity A considers if the tickets are both quantitatively and qualitatively immaterial in the

context of the contract.

Entity A first concludes that the tickets are quantitatively immaterial to the contract based on an

assessment of the dollar value of the tickets compared with the other promises in the contract.

Identify the performance obligations in the contract 43

Entity A then considers the following factors in assessing whether the tickets are qualitatively immaterial

to the contract:

• Would Entity B have entered into the arrangement without the tickets?

• Were the tickets critical to the negotiation of the contract?

• Is there a relationship between the marketing services and the tickets?

Because Entity A answered “no” to all three questions, it determines that the tickets were qualitatively

immaterial in the context of the contract. As a result, Entity A does not further evaluate whether the

tickets are a performance obligation.

An entity may choose not to evaluate whether a promise is immaterial in the context of a contract, but

rather may evaluate (any or) all promises in a contract to determine if they constitute separate

performance obligations. This is because the guidance is written to allow an entity flexibility in deciding

whether to evaluate a promise as immaterial, or proceed instead to determine if the promise is a

performance obligation.

The relief from evaluating immaterial promises, however, does not apply to customer options when the

options provide the customer with a material right (for example, loyalty points that may be immaterial in

the context of a single contract). Material rights are discussed further in Section 4.4.

ASC 606-10-25-16B

An entity shall not apply the guidance in paragraph 606-10-25-16A to a customer option to acquire

additional goods or services that provides the customer with a material right, in accordance with

paragraphs 606-10-55-41 through 55-45.

Costs related to immaterial promises

4The costs related to transferring goods or services that are immaterial in the context of the contract

should be accrued when the revenue related to a performance obligation that includes those goods or

services is recognized before the immaterial goods or services are transferred to the customer. We

believe that the costs related to goods or services that are immaterial in the context of the contract should

be classified consistently with the costs of the performance obligation that includes the immaterial goods

or services. For example, an entity that sells equipment offers customers a one-hour training course

within three months after delivery. The entity concludes that the training promise is immaterial in the

context of the contract and recognizes the cost of training and the cost of the equipment in the cost of

goods sold when control of the equipment transfers to the customer and revenue is recognized.

Shipping and handling

In some cases, an entity performs shipping and handling activities in connection with a contract for its

goods. If an entity performs shipping and handling activities after it transfers control of the goods to the

customer, the entity may elect to account for shipping and handling costs as a fulfillment cost (an

expense) rather than as a promised service within the contract that must be evaluated to determine if it is

a distinct performance obligation (as discussed in Section 4.2). The entity should apply the accounting

policy election consistently to similar types of transactions. When an entity makes this election and

Identify the performance obligations in the contract 44

recognizes revenue before the shipping and handling activities occur, the entity should accrue the related

shipping and handling costs. BC23 of ASU 2016-10 indicates that this guidance cannot be applied by

analogy to activities other than shipping and handling.

ASC 606-10-25-18B

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. The entity shall apply this accounting policy election consistently to similar types of transactions.

An entity that makes this election would not evaluate whether shipping and handling activities are

promised services to its customers. If revenue is recognized for the related good before the shipping

and handling activities occur, the related costs of those shipping and handling activities shall be

accrued. An entity that applies this accounting policy election shall comply with the accounting policy

disclosure requirements in paragraphs 235-10-50-1 through 50-6.

Shipping and handling activities that occur after control of the goods transfers

Entity A produces small motors. The motors are not customized in any way for any particular customer.

Entity A considers the following in determining that control of the motors transfers upon leaving its

shipping docks:

• Entity A has an enforceable right to payment at the shipping point.

• Entity A uses an insured carrier for its shipments and the carrier will reimburse the legal title holder

for lost or damaged goods.

• Legal title to the parts transfers to the customer at the shipping point.

• There are no customer acceptance criteria included in the contract or established by past practice.

Entity A makes an accounting policy election to account for shipping and handling as a fulfillment cost

for all of its motors for which control transfers upon shipment. As a result, Entity A recognizes revenue

for the motors (including any fee for the shipping) and accrues the related shipping costs when control

of the motors transfers upon shipment of the parts from the entity’s shipping docks.

Shipping and handling activities that occur before the customer obtains control of the good are activities

to fulfill the entity’s promise to transfer the good and are not a promised service to the customer.

Preproduction activities

Some long-term supply arrangements require an entity to undertake efforts up-front to mobilize

equipment or to design new technology or equipment, which are referred to as preproduction activities.

Preproduction activities are often necessary before delivering any units under a manufacturing contract.

Section 11.3 includes a discussion of the accounting considerations related to preproduction activities,

including guidance on when preproduction activities are separate performance obligations.

Identify the performance obligations in the contract 45

Stand-ready promises

A stand-ready promise is one whereby an entity promises a service of “standing ready” to provide goods

and/or services, or it makes the goods or services available for a customer to use as and when the

customer decides.

The concept of “standing ready” has been discussed by the TRG to help stakeholders distinguish these

types of obligations from others.

TRG area of general agreement: What is the nature of the promise in a stand-ready

obligation?

At its January 2015 meeting,

the TRG reached a general agreement that entities will need to

exercise judgment to determine whether the nature of the entity’s promise is to stand ready to provide

goods or services or to actually provide the underlying specified goods or services, which would not be

a stand-ready obligation. An indicator as to the nature of the entity’s promise might be when the

entity’s obligation is to provide a defined good or service, which would indicate that the nature of the

entity’s promise is to provide those underlying specified goods or services. If instead the entity

determines that the nature of its obligation is to provide an unknown type or quantity of goods or

services, this indicates that the nature of the entity’s promise is to stand ready.

Judgment is necessary to determine when a promise is to stand ready as many contracts call for the

entity to be prepared to provide the goods or services at the discretion of the customer, but not all such

promises would necessarily lead to stand-ready performance obligations.

TRG Paper 16 includes the following four broad types of promises made to customers that could be

considered stand-ready obligations.

TRG Paper 16, Stand-Ready Performance Obligations.

Identify the performance obligations in the contract 46

Type

Description

Examples

Obligations in which the

delivery of a good, service,

or intellectual property

underlying the obligation is

controlled by the entity, but

the item must still be further

developed

A software vendor promises to transfer unspecified

software upgrades at the vendor’s discretion.

A pharmaceutical company promises to provide when-

and-if-available updates to previously licensed

intellectual property based on advances in research

and development.

Obligations in which the

delivery of the underlying

good or service is outside

the control of the entity and

the customer

An entity promises to remove snow from an airport’s

runways in exchange for a fixed fee over a one-year

period.

Obligations in which the

delivery of the underlying

good or service is controlled

by the customer

An entity agrees to provide periodic maintenance,

when-and-if-needed, to customer’s equipment after a

pre-established amount of usage by the customer.

Obligations where a good or

service is available to the

customer continuously

An entity provides the customer unlimited access to a

health club for a specified time.

The TRG agreed that in arrangements B, C, and D above, the entity promises to provide an uncertain

quantity of goods or services and therefore the entity is “standing ready” to perform. With regard to

Type A, an entity needs to evaluate whether its promise is for specified or unspecified updates. As

noted in the example above, the nature of the entity’s promise is to “stand ready” when its promise is to

transfer unspecified upgrades or to provide when-and-if-available updates if the entity is unable to

predict the timing of when those upgrades or updates will be made available. On the other hand, an

entity should account for its promise to deliver a specified update as it would any other license of

intellectual property. Determining whether a promise is for a specified or an unspecified update can be

challenging and an entity may conclude that an arrangement includes both specified and unspecified

updates.

In BC160 of ASU 2014-09, the Boards noted that in a typical health club contract, the entity’s promise

is to stand ready by making the health club available for a period of time, rather than providing a

service only when a member requests it. That is, the member benefits from the entity’s service of

making the health club available on a continuous basis. The extent to which the member uses the

health club does not, in itself, affect the amount of the remaining goods or services to which the

member is entitled. Further, the member must pay for the health club membership regardless of

whether, or how often, it uses the club. As a result, for a stand-ready obligation, an entity should select

a measure of progress (Section 7.1.2) based on its service of making goods or services available

instead of when customers use the goods or services made available to them.

Identify the performance obligations in the contract 47

4.2 Identifying performance obligations

After identifying the implicit and explicit promises in the contract, the entity must evaluate each promise to

determine if that promise constitutes a performance obligation. This evaluation is performed at contract

inception.

ASC 606 provides the following guidance on identifying performance obligations. Keep in mind that a

performance obligation may be a distinct good or service, or it may comprise a series of distinct goods or

services, such as a repetitive service contract or contract for the sale of goods where the services

performed or goods sold are substantially the same, and are transferred to the customer in a similar

manner throughout the contract, and meet the over time revenue recognition criteria (see Section 7.1.1).

ASC 606-10-25-14

At contract inception, an entity shall assess the goods or services promised in a contract with a

customer and shall identify as performance obligations each promise to transfer to the customer either:

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

b. A series of distinct goods or services that are substantially the same and that have the same

pattern of transfer to the customer (see paragraph 606-10-25-15).

ASC 606-10-25-19

A good or service that is promised to a customer is distinct if both of the following criteria are met:

a. The customer can benefit from the good or service either on its own or together with other

resources that are readily available to the customer (that is, the good or service is capable of being

distinct).

b. The entity’s promise to transfer the good or service to the customer is separately identifiable from

other promises in the contract (that is, the good or service is distinct within the context of the

contract).

Accordingly, an entity accounts for a promise as a separate performance obligation if the promise meets

the criteria to be distinct or if it represents a series of distinct goods or services. These criteria are

explained in more detail below.

A performance obligation is a promise in a contract with a customer to transfer to the

customer either:

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

b. A series of distinct goods or services that are substantially the same and that have the

same pattern of transfer to the customer.

Identify the performance obligations in the contract 48

Figure 4.3: Identifying performance obligations

As noted in Figure 4.3, there may be situations where an entity combines a distinct good or service with

other non-distinct goods or services to arrive at a bundle of distinct goods or services. The guidance in

ASC 606 requires that if the promised good or service under evaluation is not deemed to be distinct, the

entity needs to combine that good or service with other promises until it identifies a bundle that is distinct.

As noted in ASC 606-10-25-22, sometimes that may result in an entity combining all of the goods or

services in a contract into a single performance obligation.

ASC 606-10-25-22

If a promised good or service is not distinct, an entity shall combine that good or service with other

promised goods or services until it identifies a bundle of goods or services that is distinct. In some

cases, that would result in the entity accounting for all the goods or services promised in a contract as

a single performance obligation.

Capable of being distinct

The first criterion for being “distinct” is that the customer can benefit from the good or service either on its

own or together with other resources that are readily available (that is, the good or service is capable of

being distinct).

Is the promised good or service both

1. Capable of being distinct

(Section 4.2.1)?

2. Distinct in the context of the

contract (Section 4.2.2)?

(ASC 606-10-25-19 through 25-22)

For a series of distinct goods or

services that are substantially the

same, would an entity both

1. Account for each good or service

in the series as a performance

obligation satisfied over time?

2. Use the same method to measure

progress for each distinct good or

service in the series?

(ASC 606-10-25-15)

Distinct guidance

Series guidance (see Section 4.3)

Identify the promise

as a separate performance

obligation.

The promise is

combined with other

promises in the contract

until a bundle of goods or

services that is distinct

is identified.

Identify the performance obligations in the contract 49

A customer can benefit from a good or service on its own if the good or service can be used, consumed,

sold for an amount greater than scrap value, or otherwise held in a way that generates economic benefits.

Sometimes, a customer can benefit from a good or service only with other readily available resources. A

“readily available resource” is a good or service that is sold separately (by the entity or by another entity)

or one that the customer has already obtained from the entity or from other events or transactions.

The fact that the entity regularly sells a good or service on its own is an indicator that the good or service

is capable of being distinct.

In BC100 of ASU 2014-09, the Boards observed that the assessment of whether the customer can benefit

from a good or service on its own should be based on the characteristics of the goods or services

themselves, excluding contractual limitations that might preclude the customer from obtaining readily

available resources from a source other than the entity. For example, if a contract states that a customer

can purchase a specific good or service only from the entity, that provision is irrelevant in determining if

the customer can benefit from the goods or services on their own.

Further, BC101 of ASU 2014-09 states that an entity does not need to assess the customer’s intended

use in determining whether a good or service is capable of being distinct because it would be difficult, if

not impossible, for an entity to know the customer’s intended use of a good or service in a given contract.

Distinct within the context of the contract

In some situations, separately accounting for each promised good or service that is capable of being

distinct would not faithfully represent the entity’s performance in the contract. As a result, the Boards

developed a second criterion that must be met for an entity to conclude that a good or service is distinct

and is thus a performance obligation to be accounted for separately.

The second criterion for being “distinct” is that the entity’s promise to transfer the good or service to the

customer is separately identifiable from other promises in the contract—that is, the promise to transfer the

good or service is distinct within the context of the contract.

In assessing whether an entity’s promise to transfer a good or service to the customer is distinct within the

context of the contract, the objective is to determine whether the nature of the contractual promise is to

transfer each of the goods or services individually or instead to transfer a combined item to which the

promised goods or services are inputs. Significant judgment may be required to determine whether

promised goods or services are distinct within the context of the contract.

The guidance provides factors that indicate that a promise to transfer goods or services is not separately

identifiable from other goods or services in the contract.

ASC 606-10-25-21

In assessing whether an entity’s promises to transfer goods or services to the customer are separately

identifiable in accordance with paragraph 606-10-25-19(b), the objective 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 or items to which the promised goods or services

are inputs. Factors that indicate that two or more promises to transfer goods or services to a customer

are not separately identifiable include, but are not limited to, the following:

a. 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 represent the combined

Identify the performance obligations in the contract 50

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 or outputs specified by the

customer. A combined output or outputs might include more than one phase, element, or unit.

b. One or more of the goods or services significantly modifies or customizes, or are significantly

modified or customized by, one or more of the other goods or services promised in the contract.

c. The goods or services are highly interdependent or highly interrelated. In other words, each of the

goods or services is significantly affected by one or more of the other goods or services in the

contract. For example, in some cases, two or more goods or services are 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.

Determining whether goods and installation services are distinct

Manufacturer A enters into a contract with Customer B for equipment and installation services.

Manufacturer A always sells new equipment bundled with installation services to its customers.

Because Manufacturer A sells the installation services to secondary purchasers of its equipment, it

concludes that the equipment is capable of being distinct, since the equipment can be used with another

readily available resource. The entity also conclude that the installation services are capable of being

distinct because these services can be used with the equipment that has already been delivered (that is,

the equipment is a readily available resource).

When evaluating whether the equipment and installation services are distinct in the context of the

contract, Manufacturer A might consider the following factors:

• Is Manufacturer A providing a significant service of integrating the equipment and installation

services?

• Do the installation services significantly modify or customize the equipment?

• Are the installation services and equipment significantly affected by each other, so that

Manufacturer A is unable to fulfill its promise to Customer B if the equipment and installation

services are transferred individually? Are the equipment and services highly interdependent or

interrelated?

The following select examples from ASC 606 demonstrate how to apply this guidance.

Example 11—Determining Whether Goods or Services are Distinct

Case A—Distinct Goods or Services (excerpt)

ASC 606-10-55-141

An entity, a software developer, enters into a contract with a customer to transfer a software license,

perform an installation service, and provide unspecified software updates and technical support (online

and telephone) for a two-year period. The entity sells the license, installation, and technical support

separately. The installation service includes changing the web screen for each type of user (for

Identify the performance obligations in the contract 51

example, marketing, inventory management, and information technology). The installation service is

routinely performed by other entities and does not significantly modify the software. The software

remains functional without the updates and the technical support.

ASC 606-10-55-142

The entity assesses the goods and services promised to the customer to determine which goods and

services are distinct in accordance with paragraph 606-10-25-19. The entity observes that 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 together with the software license

transferred at the outset of the contract. Thus, the entity concludes that the customer can benefit from

each of the goods and services either on their own or together with the other goods and services that

are readily available and the criterion in paragraph 606-10-25-19(a) is met.

ASC 606-10-55-143

The entity also considers the principle and the factors in paragraph 606-10-25-21 and determines that

the promise to transfer each good and service to the customer is separately identifiable from each of the

other promises (thus the criterion in 606-10-25-19(b) is met). In reaching this determination, the entity

considers that 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 alternate providers. The software updates do

not significantly affect the customer’s ability to use and benefit from the software license because in

contrast with Example 10 (Case C), the software updates in this contract are not necessary to ensure

that the software maintains a high level of utility to the customer during the license period. The entity

further observes that none of the promised goods or services significantly modifies or customizes one

another and the entity does not provide a significant service of integrating the software and the services

into a combined output. Lastly, the entity concludes that the software and services do not significantly

affect each other and, therefore, are not highly interdependent or highly interrelated because the entity

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.

ASC 606-10-55-144

On the basis of this assessment, the entity identifies four performance obligations in the contract for the

following goods or services:

a. Software license

b. Installation service

c. Software updates

d. Technical support.

Identify the performance obligations in the contract 52

Example 11—Determining Whether Goods or Services are Distinct

Case E—Promises are Separately Identifiable (Consumables) (excerpt)

ASC 606-10-55-150G

An entity enters into a contract with a customer to provide a piece of off-the-shelf equipment (that is, it is

operational without any significant customization and modification) and to provide specialized

consumables for use in the equipment at predetermined intervals over the next three years. The

consumables are produced only by the entity, but are sold separately by the entity.

ASC 606-10-55-150H

The entity determines that the customer can benefit from the equipment together with the readily

available consumables. The consumables are readily available in accordance with paragraph

606-10-25-20 because they are regularly sold separately by the entity (that is, through refill orders to

customers that previously purchased the equipment). The customer can benefit from the consumables

that will be delivered under the contract together with the delivered equipment that is transferred to the

customer initially under the contract. Therefore, the equipment and consumables are each capable of

being distinct in accordance with paragraph 606-10-25-19(a).

ASC 606-10-55-150I

The entity determines that its promises to transfer the equipment and to provide consumables over a

three-year period are each separately identifiable in accordance with paragraph 606-10-25-19(b). In

determining that the equipment and the consumables are not inputs to a combined item in this contract,

the entity considers that it is not providing a significant integration service that transforms the equipment

and consumables into a combined output. Additionally, neither the equipment nor the consumables are

significantly customized or modified by the other. Lastly, the entity concludes that the equipment and the

consumables are not highly interdependent or highly interrelated because they do not significantly affect

each other. Although the customer can benefit from the consumables in this contract only after it has

obtained control of the equipment (that is, the consumables would have no use without the equipment)

and the consumables are required for the equipment to function, the equipment and the consumables

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 equipment even if the customer did not purchase any consumables and would be able to

fulfill its promise to provide the consumables even if the customer acquired the equipment separately.

ASC 606-10-55-150J

On the basis of this assessment, the entity identifies two performance obligations in the contract for the

following goods or services:

a. The equipment

b. The consumables

Identify the performance obligations in the contract 53

The factors indicating that two or more promises are not separately identifiable are not an exhaustive list,

and not all of the factors need to be met to determine whether an entity’s promises to transfer goods or

services are separately identifiable. The Boards observed

that the factors are not mutually exclusive

because each factor is based on the same underlying principle of inseparable risks. The factors are each

evaluated in more detail below.

Significant integration service

The first factor that indicates that two or more promises to transfer goods or services are not separately

identifiable from other goods or services in the contract is that the entity provides significant integration

services. Stated differently, the entity is using the goods or services as inputs to produce the combined

output called for in the contract.

BC107 of ASU 2014-09 indicates that the Boards observed that this factor may be relevant for many

construction contracts where a contractor provides a significant integration service and assumes the risk

of integrating the various construction tasks. The factor may also apply to other industries and contracts.

Example 10—Goods and Services are Not Distinc

Case A—Significant Integration Service

ASC 606-10-55-137

An entity, a contractor, enters into a contract to build a hospital for a customer. The entity is responsible

for the overall management of the project and identifies various promised goods and services, including

engineering, site clearance, foundation, procurement, construction of the structure, piping, and wiring,

installation of equipment, and finishing.

ASC 606-10-55-138

The promised goods and services are capable of being distinct in accordance with paragraph 606-10-

25-19(a). That is, the customer can benefit from the goods and services either on their own or together

with other readily available resources. This is evidenced by the fact that the entity, or competitors of the

entity, regularly sells many of these goods and services separately to other customers. In addition, the

customer could generate economic benefit from the individual goods and services by using, consuming,

selling, or holding those goods or services.

ASC 606-10-55-139

However, the promises to transfer the goods and services are not separately identifiable in accordance

with paragraph 606-10-25-19(b) (on the basis of the factors in paragraph 606-10-25-21). This is

evidenced by the fact that the entity provides a significant service of integrating the goods and services

(the inputs) into the hospital (the combined output) for which the customer has contracted.

ASC 606-10-55-140

Because both criteria in paragraph 606-10-25-19 are not met, the goods and services are not distinct.

The entity accounts for all of the goods and services in the contract as a single performance obligation.

BC106, ASU 2014-09.

Identify the performance obligations in the contract 54

Grant Thornton insight: Service and equipment that are distinct within the context

of the contract

At the 2018 AICPA Conference on Current SEC and PCAOB Developments,

one speech related to

the evaluation of arrangements with equipment and subscription services to determine whether the two

promises are distinct. The SEC staff discussed a consultation in which a registrant provided its

customer with commercial security monitoring services along with integrated cameras and sensors (the

equipment), which are integrated with the registrant’s technology platform. The equipment is integrated

through a control panel that is installed at the customer’s location, allowing the equipment to

communicate with the technology platform. The technology allows the cameras and sensors to “learn”

from historical data to create a “smart” security monitoring service.

The registrant concluded that each piece of equipment, the installation, and the monitoring services

were capable of being distinct, but were not distinct in the context of the contract because the registrant

provided a significant integration service, which resulted in a combined output of a “smart security

monitoring service.” The staff did not object as the registrant demonstrated reasonable judgment in

concluding that the integration service transformed the equipment into a combined output that was

greater than the sum of the individual parts.

We believe that the following indicators should be considered when determining whether the nature of

a promise to a customer is to transfer a combined item, such as security monitoring services as in the

SEC staff speech, or each item individually:

• Are the equipment and services sold separately?

• Do the services significantly modify the equipment?

• Is the functionality of the combined equipment and services transformative or, said another way,

greater than the sum of the individual parts?

• Is the equipment sold on a stand-alone basis, including in an aftermarket?

• How is the arrangement described in marketing materials and public filings?

Grant Thornton insight: Bundle of goods and services provided as a ‘solution’

Many entities call a bundle of goods and services a “solution” in their marketing materials or in the way

that they describe the combination of goods in services when evaluating a contract with a customer

under ASC 606. Calling the bundle a “solution” is insufficient in concluding that promised goods and

services comprise a single, or bundled, performance obligation.

In fact, during the 2019 AICPA Conference on Current SEC and PCAOB Developments,

the SEC

staff noted that registrants sometimes try to support a conclusion that bundled goods and services

2018 AICPA Conference on Current SEC and PCAOB Developments, Speech by Sheri L. York,

Professional Accounting Fellow, Office of the Chief Accountant.

2019 AICPA Conference on Current SEC and PCAOB Developments, Speech by Susan M. Mercier,

Professional Accounting Fellow, Office of the Chief Accountant.

Identify the performance obligations in the contract 55

comprise a single performance obligation by asserting that the “customer wants” the promised goods

and services as a “solution.” While the term “solution” may be commonly used in marketing materials

describing the goods and services, the SEC staff said that using the word “solution” does not result in a

presumption that the promised goods and services that make up the “solution” should be bundled into

one performance obligation. Instead, the staff said that entities must use the guidance in ASC 606-10-

25-21 to support the assertion that promises to transfer goods or services are not separately

identifiable. Additionally, entities may also find useful the guidance in BC29 in ASU 2016-10, which

states that entities might consider whether the combined output of the promises is greater than, or

substantively different from, the sum of the promised goods or services.

Significant modification or customization

The second factor that indicates that two or more promises to transfer goods or services are not

separately identifiable from other goods or services in the contract is that one or more of the goods or

services significantly modifies or customizes other promised goods or services in the contract.

In some industries, such as the software industry, the notion of inseparable risks is more clearly illustrated

by assessing whether one good or service significantly modifies or customizes another good or service in

the contract. In this case, the goods or services are inputs to create a combined output—a customized

product.

Example 11—Determining Whether Goods or Services are Distinct

Case B—Significant Customization (excerpt)

ASC 606-10-55-146

The promised goods and services are the same as in [Example 11] Case A, except that the contract

specifies that, as part of the installation service, the software is to be substantially customized to add

new functionality to enable the software to interface with other customized software applications used

by the customer. The customized installation service can be provided by other entities.

ASC 606-10-55-147

The entity assesses the goods and services promised to the customer to determine which goods and

services are distinct in accordance with paragraph 606-10-25-19. The entity first assesses whether the

criterion in paragraph 606-10-25-19(a) has been met. For the same reasons as in Case A, the entity

concludes that the software license, installation, software updates, and technical support each meet that

criterion. The entity next assesses whether the criterion in paragraph 606-10-25-19(b) has been met by

evaluating the principle and the factors in paragraph 606-10-25-21. The entity observes that the terms

of the contract 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 entity is using the license and the customized installation service as inputs to

produce the combined output (that is, a functional and integrated software system) specified in the

contract (see paragraph 606-10-25-21(a)). The software is significantly modified and customized by the

service (see paragraph 606-10-25-21(b)). Consequently, the entity determines that the promise to

transfer the license is not separately identifiable from the customized installation service and, therefore,

the criterion in paragraph 606-10-25-19(b) is not met. Thus, the software license and the customized

installation service are not distinct.

Identify the performance obligations in the contract 56

ASC 606-10-55-148

On the basis of the same analysis as in Case A, the entity concludes that the software updates and

technical support are distinct from the other promises in the contract.

ASC 606-10-55-149

On the basis of this assessment, the entity identifies three performance obligations in the contract for

the following goods or services:

a. Software customization which is comprised of the license to the software and the customized

installation service

b. Software updates

c. Technical support.

Highly interdependent or highly interrelated

The third factor that indicates that two or more promises to transfer goods or services are not separately

identifiable from other goods or services in the contract is that the goods or services are highly

interdependent or highly interrelated.

The Boards included this factor because, in some cases, it may be unclear whether the entity provides an

integration service or whether the goods or services are significantly modified or customized; yet the

individual goods or services are not separately identifiable from other goods or services because they are

highly dependent on, or highly interrelated with, other promised goods or services in the contract.

As stated in BC32 of ASU 2016-10, the principle in evaluating whether promises are “distinct within the

context of the contract” is to consider the level of integration, interrelation, or interdependence among

promises to transfer goods or services. As a result, the entity must evaluate whether two or more

promised goods or services significantly affect the other and are therefore highly interdependent or highly

interrelated with other promised goods or services in the contract. An entity does not simply evaluate

whether one item depends on another. There must be a two-way dependency. In other words, instead of

concluding that an undelivered item would never be obtained by a customer absent the delivered item in

the contract, the entity would consider whether the undelivered item and the delivered item each

significantly affect the other and therefore are highly interdependent or highly interrelated.

Example 10—Goods and Services are Not Distinct

Case B—Significant Integration Service

ASC 606-10-55-140A

An entity enters into a contract with a customer that will result in the delivery of multiple units of a highly

complex, specialized device. The terms of the contract require the entity to establish a manufacturing

process in order to produce the contracted units. The specifications are unique to the customer based

on a custom design that is owned by the customer and that were developed under the terms of a

separate contract that is not part of the current negotiated exchange. The entity is responsible for the

overall management of the contract, which requires the performance and integration of various activities

Identify the performance obligations in the contract 57

including procurement of materials; identifying and managing subcontractors; and performing

manufacturing, assembly, and testing.

ASC 606-10-55-140B

The entity assesses the promises in the contract and determines that each of the promised devices is

capable of being distinct in accordance with paragraph 606-10-25-19(a) because the customer can

benefit from each device on its own. This is because each unit can function independently of the other

units.

ASC 606-10-55-140C

The entity observes that the nature of its promise is to establish and provide a service of producing the

full complement of devices for which the customer has contracted in accordance with the customer’s

specifications. The entity considers that it is responsible for overall management of the contract 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) and, therefore, the devices and the various

promised goods and services inherent in producing those devices are not separately identifiable in

accordance with paragraphs 606-10-25-19(b) and 606-10-25-21. In this Case, the manufacturing

process provided by the entity is specific to its contract with the customer. In addition, the nature of the

entity’s performance and, in particular, the significant integration service of the various activities mean

that a change in one of the entity’s activities to produce the devices has a significant effect on the other

activities required to produce the highly complex specialized devices such that the entity’s activities are

highly interdependent and highly interrelated. Because the criterion in paragraph 606-10-25-19(b) is not

met, the goods and services that will be provided by the entity are not separately identifiable, and,

therefore, are not distinct. The entity accounts for all of the goods and services promised in the contract

as a single performance obligation.

4.3 Series of distinct goods or services

When an entity provides the same distinct goods or services over a period of time (for example, a

repetitive service contract for cleaning), it needs to consider if the promised goods or services in the

contract meet the requirements of the “series guidance” (see Figure 4.4). Under the series guidance, an

entity must account for a series of distinct goods or services that are substantially the same and that have

the same pattern of transfer to the customer as a single performance obligation. The guidance is not

optional. In other words, if a series of distinct goods or services meets the criteria in

ASC 606-10-25-14(b), an entity is required to account for the series as a single performance obligation

rather than accounting for the goods or services as individual performance obligations.

A series of distinct goods or services has the same pattern of transfer to the customer if both

• Each distinct good or service in the series would be accounted for as a performance obligation

satisfied over time (Section 7.1).

• The entity would use the same method to measure progress toward complete satisfaction of the

performance obligation to transfer each distinct good or service in the series to the customer

(Section 7.1.2).

Identify the performance obligations in the contract 58

ASC 606-10-25-15

A series of distinct goods or services has the same pattern of transfer to the customer if both of the

following criteria are met:

a. Each distinct good or service in the series that the entity promises to transfer to the customer would

meet the criteria in paragraph 606-10-25-27 to be a performance obligation satisfied over time.

b. In accordance with paragraphs 606-10-25-31 through 25-32, 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.

BC113 of ASU 2014-09 states that the Boards included the series guidance to simplify the application of

the model and to promote consistency in the identification of performance obligations when an entity

provides the same good or service repetitively over a period of time. Without this guidance, an entity

would be required to allocate the overall consideration in such a contract to each distinct good or service

(for example, each day of cleaning in a five-year service contract).

Accordingly, correctly determining whether the series guidance applies is important because it may

impact the subsequent accounting.

Figure 4.4: Applicability of the series guidance

Does each distinct good or service meet the criteria to

be a performance obligation satisfied over time?

Does the entity use the same measure of progress for

each distinct good or service?

Identify the entire series as a single performance

obligation (not optional).

Series

guidance

does not

apply.

Does the contract include a series of distinct goods or

services that are substantially the same?

Identify the performance obligations in the contract 59

TRG area of general agreement: How does the accounting treatment vary if an entity

determines the series guidance applies?

An entity may conclude that a bundle of goods and services is a single performance obligation either

because (1) the bundle includes goods and services that are not distinct, or (2) the bundle includes a

series of distinct goods and services and the series guidance applies.

At the March 2015 meeting,

the TRG discussed areas in which the accounting treatment may vary

depending on why an entity determines its promise is a single performance obligation, including the

following examples:

• Allocation of variable consideration: ASC 606-10-32-40 indicates that if certain criteria are met, an

entity may allocate a variable amount entirely to a performance obligation or to a distinct good or

service that forms part of a single performance obligation accounted for as a series. For example,

assume that an entity concludes that the series guidance applies and the criteria are met to

allocate variable consideration (such as a performance bonus) to an increment of time within the

series. The timing of revenue recognition in that fact pattern may differ from a situation where the

entity concludes that the series guidance does not apply and it therefore would not allocate the

variable consideration to a specific increment of time.

• Contract modifications: Generally, if the remaining undelivered goods or services are distinct,

including parts of a single performance obligation accounted for as a series, a contract modification

would be accounted for on a prospective basis. However, if the remaining goods and services are

not distinct, the modification would result in a cumulative adjustment to revenue.

• Changes in transaction price: The guidance regarding changes in the transaction price in

ASC 606-10-32-42 to 32-45 may apply differently to a single performance obligation resulting from

the series guidance than a single performance obligation of non-distinct goods or services.

Grant Thornton insight: What are some examples of goods or services that constitute a

series?

There are various examples of services in ASC 606 that constitute a series, including the following:

• Example 7: An entity provides weekly cleaning services to a customer for three years.

• Example 12A: A hotel manager provides hotel management services to a customer for 20 years.

• Example 13: An entity provides monthly payroll processing services to a customer for one year.

• Example 25: An entity provides asset management services to a client for five years.

Even though each instance of service (that is, each hour or day of service) is distinct, the entity

accounts for each of these contracts as a single performance obligation because the entity transfers a

series of distinct services that are substantially the same and that have the same pattern of transfer to

the customer in each case. In other words, each service meets the over time criteria in ASC 606-10-25-

TRG Paper 27, Series of Distinct Goods or Services.

Identify the performance obligations in the contract 60

27 and the entity uses the same method to measure its progress (that is, a time-based measure) in

each case.

Other goods or services that might constitute a series include, but are not limited to, the following

examples:

• A software as a service (SaaS) company providing a customer with continuous access to its

platform

• A telecommunications company providing network access to customers over a period of time

The TRG discussed how an entity determines if the underlying distinct goods or services are

“substantially the same.” The discussion suggests that the entity must first determine the nature of its

promise to the customer.

TRG area of general agreement: How should an entity consider whether the

performance obligation consists of distinct goods or services that are

‘substantially the same’?

While discussing this question during the July 2015 meeting,

the TRG addressed how broadly or

narrowly the guidance in ASC 606 should be applied, since an entity evaluating time increments in a

services contract would need to conclude that each time increment is distinct and is substantially the

same.

The TRG members generally agreed that an entity must first determine the nature of its promise in

providing the service to the customer.

If the nature of the entity’s promise is to deliver a specified quantity of a service, the entity should

evaluate whether each service is distinct and substantially the same. If the nature of the entity’s

promise is the act of standing ready or providing a single service for a period of time, the entity may

consider whether each time increment (for example, each day or hour), rather than the underlying

activity, is distinct and substantially the same. The Boards intended that a series could consist of either

distinct time increments or the good or service delivered, depending on the nature of the promise.

In ASC 606, Example 13, an entity enters into a contract to provide monthly payroll processing services

to a customer for one year. The nature of the entity’s promise is to deliver a specified quantity of a

service—12 distinct instances of payroll processing. It is not a promise to stand ready to perform an

undefined number of processing tasks. As a result, the entity evaluates whether each instance of

payroll processing is distinct and substantially the same.

In contrast, Example 12A in ASC 606 describes a hotel manager that enters into a contract with a

customer to manage a customer-owned property for 20 years. The hotel management service

comprises various activities that may vary by day (for example, cleaning service, reservation services,

and property maintenance).

In this contract, the nature of the promise is the act of standing ready to provide the hotel management

service each day because the entity has promised to provide an unspecified quantity of activities rather

TRG Paper 39, Application of the Series Provision and Allocation of Variable Consideration.

Identify the performance obligations in the contract 61

than a defined number of services. Accordingly, the entity considers whether each time increment is

distinct and substantially the same.

A question was raised to the TRG about whether goods must be delivered or services must be

performed consecutively to apply the series guidance.

TRG area of general agreement: In order to apply the series guidance, must the goods

be delivered or services be performed consecutively?

During the March 2015 meeting,

the TRG discussed a question raised by stakeholders as to whether

the series provision applies when there is a gap or an overlap in the entity’s delivery of goods or

performance of services. While the term “consecutively” is not used in ASC 606, it is used in the Basis

for Conclusions

. The TRG considered the following two examples:

Example A: An entity has contracted with a customer to provide a manufacturing service in

which it will produce 1,000 units of a product per month for a 2-year period. The service will be

performed evenly over the 2-year period with no breaks in production. The units produced

under this service arrangement are substantially the same and are manufactured to the

specifications of the customer. The entity does not incur significant up-front costs to develop

the production process. Assume that its service of producing each unit is a distinct service in

accordance with the criteria in paragraph 606-10-25-19. Additionally, the service is accounted

for as a performance obligation satisfied over time in accordance with paragraph 606-10-25-27

because the units are manufactured specific to the customer (such that the entity’s

performance does not create an asset with an alternative use to the entity), and if the contract

were to be cancelled, the entity has an enforceable right to payment (cost plus a reasonable

profit margin). Therefore, the criteria in paragraph 606-10-25-15 have both been met.

Example B: Assume the same facts as the example above, except that different from

Example A, the entity does not plan to perform evenly over the 2-year service period. That is,

the entity does not produce 1,000 units a month, continuously. Instead, the entity plans to

perform the manufacturing service over the 2-year period, but in achieving the production

targets, the entity produces 2,000 units in some months and zero units in other months.

The TRG generally agreed that in order to apply the series guidance, the entity need not deliver the

goods nor perform the services consecutively. In other words, the guidance still applies when there is a

gap in delivery or service. While an entity may consider the pattern of performance in determining the

measure of progress towards satisfying its performance obligation, the consideration of whether the

pattern of performance is consecutive is not an explicit requirement in ASC 606-10-25-15 and therefore

is not determinative as to whether the series provision applies. As a result, both Example A and B

would be accounted for as single performance obligations in accordance with the series provision.

TRG Paper 27, Series of Distinct Goods or Services.

BC113 and BC116, ASU 2014-09.

Identify the performance obligations in the contract 62

4.4 Customer options for additional goods or services

An entity that sells goods or services may also provide customers with an option to acquire additional

goods or services for free or at a discount, for example, sales incentives, award credits or points, and

renewal options. Under ASC 606, an entity must identify the option as a separate performance obligation

if the option represents a “material right” to the customer that the customer would not have received

without entering into that contract. If the option does not provide the customer with a material right, the

option is considered a marketing offer.

As noted in Section 4.1.1, the relief from evaluating immaterial promises does not apply to customer

options that provide a material right.

ASC 606 does not specify what constitutes a material right, but does provide as an example “a discount

that is incremental to the range of discounts typically given for the goods or services to a particular class

of customer in a geographical area or market.”

BC386 of ASU 2014-09 explains that the purpose of the guidance on material rights is to distinguish

between:

• An option that the customer pays for as part of an existing contract (that is, a customer pays in

advance for future goods or services, and therefore the entity identifies the option as a performance

obligation and allocates part of the transaction price to that performance obligation)

• A marketing or promotional offer that the customer did not pay for and is not part of the contract (that

is, an effort by the entity to obtain future contracts with the customer)

ASC 606-10-55-41

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 606-10-55-42

If, in a contract, an entity grants a customer the option to acquire additional goods or services, that

option gives rise to a performance obligation in the contract only if the option provides a material right

to the customer that it would not receive without entering into that contract (for example, 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). If the option provides a material right to the customer,

the customer in effect pays the entity in advance for future goods or services, and the entity recognizes

revenue when those future goods or services are transferred or when the option expires.

ASC 606, Example 49, illustrates an option that provides the customer with a material right.

Identify the performance obligations in the contract 63

Example 49—Option that Provides the Customer with a Material Right (Discount

Voucher) (excerpt)

ASC 606-10-55-336

An entity enters into a contract for the sale of Product A for $100. As part of the contract, the entity gives

the customer a 40 percent discount voucher for any future purchases up to $100 in the next 30 days.

The entity intends to offer a 10 percent discount on all sales during the next 30 days as part of a

seasonal promotion. The 10 percent discount cannot be used in addition to the 40 percent discount

voucher.

ASC 606-10-55-337

Because all customers will receive a 10 percent 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 percent (that is, the additional 30 percent discount). The entity accounts for the promise to provide

the incremental discount as a performance obligation in the contract for the sale of Product A.

If the option only allows the customer to buy additional goods or services at their stand-alone selling

price, the option will not constitute a material right. In this case, the entity has only made a marketing

offer.

ASC 606-10-55-43

If a customer has the option 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. In those

cases, the entity has made a marketing offer that it should account for in accordance with the guidance

in this Topic only when the customer exercises the option to purchase the additional goods or services.

ASC 606, Example 50, illustrates an option that does not provide the customer with a material right.

Example 50—Option That Does Not Provide the Customer with a Material Right

(Additional Goods or Services)

ASC 606-10-55-340

An entity in the telecommunications industry enters into a contract with a customer to provide a handset

and monthly network service for two years. The network service includes up to 1,000 call minutes and

1,500 text messages each month for a fixed monthly fee. The contract specifies the price for any

additional call minutes or texts that the customer may choose to purchase in any month. The prices for

those services are equal to their standalone selling prices.

ASC 606-10-55-341

Identify the performance obligations in the contract 64

The entity determines that the promises to provide the handset and network service are each separate

performance obligations. This is because the customer can benefit from the handset and network

service either on their own or together with other resources that are readily available to the customer in

accordance with the criterion in paragraph 606-10-25-19(a). In addition, the handset and network

service are separately identifiable in accordance with the criterion in paragraph 606-10-25-19(b) (on the

basis of the factors in paragraph 606-10-25-21).

ASC 606-10-55-342

The entity determines 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 (see paragraph

606-10-55-43). This is because the prices of the additional call minutes and texts reflect the standalone

selling prices for those services. 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.

Consequently, the entity does not allocate any of the 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.

Optional purchases as separate performance obligations

When an entity determines that an option provides the customer with a material right, it identifies that

option, not the underlying goods and/or services, as a separate performance obligation. In other words,

when an entity determines that an option provides the customer with a material right, it will estimate the

stand-alone selling price of the option and allocate a portion of the overall transaction price (excluding the

amount a customer would pay for purchasing the additional goods or services) to the option. Section 6.3

discusses estimating the stand-alone selling price of an option.

Stakeholders asked the TRG if economic compulsion would impact this approach. In other words, if a

customer is economically compelled to purchase additional goods or services from the entity, should the

entity include the underlying goods and/or services as performance obligations in the contract? For

example, an entity may sell equipment to a customer at a loss, hoping to make money on the subsequent

sale of consumables to the customer, which the customer is required to purchase only from the vendor

(either because the equipment functions only with the vendor’s consumables or the customer is

contractually obligated to do so). Stakeholders question, in this case, whether the vendor should include

estimated amounts from the sale of consumables in the transaction price of the equipment contract? In

other words, are the optional consumables a performance obligation in the equipment contract? The

takeaway from the TRG’s discussion is that the option is a performance obligation when it provides the

customer with a material right—that is, the underlying goods or services are not the performance

obligation. Further, if the upfront deliverable (in this case, the equipment) is considered distinct, it is

counterintuitive to conclude that the customer is economically compelled to purchase additional items

solely because they are utilized with the upfront good. If the equipment is distinct, then the customer can

benefit from it on its own without any additional goods or services, and the promise is separately

identifiable from other promises in the contract.

Identify the performance obligations in the contract 65

TRG area of general agreement: Economic compulsion

The TRG discussed the concept of “economic compulsion” and its impact on accounting for contracts

with customers at its November 2015 meeting

using the following fact pattern:

An entity enters into an exclusive contract with a customer to sell equipment and consumable

parts for the equipment (both are determined to be distinct). The equipment does not function

without the consumable part, but the customer could resell the equipment. The stand-alone

selling price of the equipment and each part are $10,000 and $100, respectively. The costs of

the equipment and each part are $8,000 and $60, respectively. The entity sells the equipment

for $6,000 (40 percent discount from stand-alone selling price) with a contractual option to

purchase each part for $100. There are no contractual minimums, but the entity estimates that

the customer will purchase 200 parts over the next two years.

Items that, as a matter of law, are optional from the customer’s perspective are not promised goods or

services in the contract. The options should instead be assessed to determine whether the customer

has a material right. In the example above, the option does not represent a material right because the

parts are priced at the stand-alone selling price. As a result, consideration that would be received for

optional parts, if the customer exercises its right, should not be included when determining the

transaction price for the initial contract.

On the flip side, if contractual penalties exist in the event the customer does not meet a minimum

purchase requirement, the entity needs to assess whether those penalties are substantive. If the

penalties are substantive, it may be appropriate to include the consideration from the goods and/or

services underlying the option as part of the contract at contract inception. The entity should also consider

whether the goods and/or services underlying the option are a performance obligation or part of a

performance obligation to which a portion of the transaction price should be allocated.

In other words, substantive penalties effectively create minimum purchase obligations if the penalty is

enforceable. If the penalties are not substantive, the consideration from the underlying goods are not

included as part of the contract, and the option is instead evaluated to determine if it provides the

customer with a material right.

The following example considers how the analysis might change when the contract includes a substantive

penalty for the customer not satisfying minimum purchase requirements.

Contractual penalty if minimum purchases not met

Print Co. sells printers and ink cartridges, both of which are distinct goods that do not meet the over time

revenue recognition criteria. The printer does not function without the ink cartridges, but the customer

could resell the printer. The stand-alone selling price of the printer is $10,000 and the stand-alone

selling price of each cartridge is $100. The costs of the printer and cartridges are $8,000 and $60,

respectively.

The seller and customer have an exclusive contract whereby the customer cannot purchase the

cartridges from other vendors during the contract term (five-year period). Print Co. sells the printer for

TRG Paper 48, Customer options for additional goods and services.

Identify the performance obligations in the contract 66

$6,000 (40 percent discount from the stand-alone selling price), with a contractual option to purchase

each cartridge for $100. The customer will incur a substantive penalty if it does not purchase at least

200 ink cartridges throughout the five-year contract term. The penalty decreases with every additional

ink cartridge purchased at a rate of $20 per ink cartridge.

The substantive penalty effectively creates a minimum purchase obligation, and therefore the entity’s

performance obligation includes the printer as well as the 200 ink cartridges.

Class of customer

As previously noted, an example of a material right is “a discount that is incremental to the range of

discounts typically given for the goods or services to a particular class of customer in a geographical area

or market [emphasis added].” Questions have arisen about how an entity should determine the “class of

customer” in making its determination of whether the option represents a material right.

TRG area of general agreement: How is the ‘class of customer’ considered when

evaluating whether a customer option gives rise to a material right?

At the April 2016 meeting,

TRG members generally agreed with the framework outlined in the staff

paper analyzing whether a material right exists. This framework suggests that customer options that

would exist independently of an existing contract with a customer do not constitute performance

obligations in that existing contract.

The staff paper includes the following example on prospective-tiered pricing:

A manufacturer produces component parts that have various uses to multiple customers. The

parts are interchangeable and not customized for any particular customer. The entity enters

into a long-term Master Supply Agreement with Customer 1 whereby the pricing of parts in

subsequent years of the contract depends on the volume in the current year. For example, the

entity charges Customer 1 $1.00 per part in Year 1 and if Customer 1’s purchases exceed

100,000 parts in Year 1, the price per part decreases to $0.90 in Year 2. The tiered pricing

(volume discount) offered to Customer 1 is similar to the terms offered to many of the entity’s

customers. Early in Year 1, Customer 1 enters into a contract with the manufacturer to

purchase 8,000 parts. Customer 1 is required to pay $1.00 for each of those 8,000 parts.

When evaluating whether the contract between the entity and Customer 1 includes a material right, the

entity first evaluates whether the option to receive a $0.10 discount per part in Year 2 exists

independently of the existing contract to purchase parts in Year 1.

To make this determination, the entity compares the discount offered to Customer 1 with the discount

typically offered to similar high-volume customers that receive a discount independent of a prior

contract with the entity.

The entity considers that Customer 2, another high-volume customer, has placed a single order with

the entity for 105,000 parts. Customer 2 has purchased parts from the entity in the past, but none of its

prior contracts with the entity created an expectation to purchase parts in the future at a specified price.

TRG Paper 54, Considering Class of Customer When Evaluating Whether a Customer Option Gives

Rise to a Material Right.

Identify the performance obligations in the contract 67

Nor did any prior contracts create an expectation for the entity to sell parts in the future at a specified

price.

Because the objective of the guidance on material rights is to determine whether the customer option

exists independently of an existing contract with a customer, the entity does not compare the price

offered to Customer 1 in Year 2 with offers to other customers receiving pricing that is contingent on

the volume of purchases in a prior year. Doing so would not help the entity determine whether

Customer 1 would have been offered the same pricing in Year 2 had it not entered into the contract to

purchase the parts in Year 1.

If the entity determines that the price offered to Customer 1 in Year 2 and the price typically offered to

Customer 2 and other similar customers are comparable, this may indicate that the price offered to

Customer 1 exists independently of the existing contract. In other words, the discount is not

incremental to the discount typically given to similar high-volume customers and is therefore not a

material right. In this case, the entity has made a marketing offer that it should account for only when

the customer exercises the option to purchase the additional goods or services.

If the entity determines the price offered to Customer 1 in Year 2 and the price typically offered to

Customer 2 and other similar customers are not comparable, this may indicate that a portion of the

price Customer 1 pays for parts in Year 1 is a prepayment for parts purchased in Year 2. In other

words, the discount provides a material right and the entity should account for the material right as a

separate performance obligation, deferring a portion of the revenue for parts sold in Year 1, allocating

that deferred revenue to the option, and recognizing that revenue when the parts purchased in Year 2

are transferred.

ASC 606 also provides examples of customer options that would not constitute material rights, including

the following:

• A discount or other right that the customer could receive without entering into the contract

• A discount that is no more than the range of discounts typically given for those goods or services to

that class of customers in that geographic area or market

• An option to acquire an additional good or service at a price that reflects the stand-alone selling price

for that good or service

MSA with several products that have varying discounts

An entity enters into a one-year MSA with a customer that features pricing as follows:

• Product A: above stand-alone selling price (SASP)

• Product B: below SASP

The customer must submit purchase orders specifying the type and quantity of product it wants to

purchase. The customer can order any mix or quantity of products throughout the MSA term; no

minimum quantities are required.

Identify the performance obligations in the contract 68

Based on prior transactions with this customer, the entity expects that the customer will initially

purchase a high volume of Product A in the first and second quarters of the contract, then shift to

primarily purchasing Product B in the third and fourth quarters.

The customer’s first purchase order is for 1,000 units of Product A at an amount above SASP. The

entity considers whether it should anticipate future purchases to determine if the contract contains a

material right related to the option to purchase Product B at an amount below SASP.

The entity considers relevant transactions, including its past, current, and anticipated transactions with

the customer when evaluating whether a material right exists.

Because the entity expects, based on

past transactions, that the customer will initially purchase Product A at an amount above SASP followed

by purchases of Product B at an amount below SASP, the entity concludes that the discounted pricing

of Product B provides a material right to the customer that it would not receive without entering into the

contract. Therefore, the entity identifies the customer’s right to purchase Product B at an amount below

SASP as a separate performance obligation and defers a portion of the transaction price from the initial

purchase of Product A.

Alternatively, if the entity lacked evidence of the customer’s pattern of purchasing Product A earlier than

Product B, the MSA pricing presumably would have been negotiated without regard for the sequence in

which the products were purchased, and there would not be a material right.

Contract renewals

Contract renewals are common options that often need to be considered in the context of the material

right guidance.

ASC 606, Example 51, illustrates a renewal option that provides the customer with a material right.

Example 51—Option that Provides the Customer with a Material Right (Renewal Option)

(excerpt)

ASC 606-10-55-343

An entity enters into 100 separate contracts with customers to provide 1 year of maintenance services

for $1,000 per contract. The terms of the contracts specify that at the end of the year, each customer

has the option to renew the maintenance contract for a second year by paying an additional $1,000.

Customers who renew for a second year also are granted the option to renew for a third year for $1,000.

The entity charges significantly higher prices for maintenance services to customers that do not sign up

for the maintenance services initially (that is, when the products are new). That is, the entity charges

$3,000 in Year 2 and $5,000 in Year 3 for annual maintenance services if a customer does not initially

purchase the service or allows the service to lapse.

ASC 606-10-55-344

The entity concludes that the renewal option provides a material right to the customer that it would not

receive without entering into the contract because the price for maintenance services are significantly

higher if the customer elects to purchase the services only in Year 2 or 3. Part of each customer’s

TRG Paper 6, Customer options for additional goods and services and nonrefundable upfront fees.

Identify the performance obligations in the contract 69

payment of $1,000 in the first year is, in effect, a nonrefundable prepayment of the services to be

provided in a subsequent year. Consequently, the entity concludes that the promise to provide the

option is a performance obligation.

Evaluating a renewal option

A golf course provides a holiday promotion to new members, granting them an option to renew their

annual membership at a discount for up to two years. The golf course sells annual memberships for

$5,000 per year. During the promotion period, members can renew their membership for $4,000 for the

second and third years. The golf course does not offer discounts on renewals outside of the promotion

period.

As discussed in TRG Paper 54,

in evaluating whether the discount provides a material right, an entity

would compare the discount offered to a customer that purchased the initial membership during the

promotional period ($1,000 off the second- and third

year renewals) with the discount typically offered to

a similar customer that did not make that same purchase.

The golf course concludes that the renewal option provides a material right to the customer because the

discount of $1,000 for the second and third years would not be available to that customer without

entering into the arrangement. In making this determination, the golf course evaluated its history of

providing discounts to new members and noted that the club does not offer a discount to members in

their first year of membership.

When an entity requires a one-time upfront payment from the customer, this may lead to a conclusion that

a renewal option constitutes a material right because the customer does not have to make that one-time

payment again in order to extend the contract. Section 4.5 further addresses the considerations for

nonrefundable upfront fees.

Accumulating rights (loyalty points)

When a customer’s right to obtain additional goods or services for free or at a discount accumulates over

a period of time, the entity will need to consider past, current, and expected future transactions with the

customer in determining whether the option provides a material right to the customer. For example, when

a coffee shop offers a loyalty program to its customers that entitles customers to a free cup of coffee after

purchasing nine cups, the entity will need to consider the accumulating nature of the rights when

determining whether the right constitutes a material right.

ASC 606, Example 52, provides an example of an entity evaluating its customer loyalty program.

TRG Paper 54, Considering Class of Customer When Evaluating Whether a Customer Option Gives

Rise to a Material Right.

Identify the performance obligations in the contract 70

Example 52—Customer Loyalty Program (excerpt)

ASC 606-10-55-353

An entity has a customer loyalty program that rewards a customer with 1 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 entity expects 9,500 points to be redeemed. The

entity estimates a standalone selling price of $0.95 per point (totaling $9,500) on the basis of the

likelihood of redemption in accordance with paragraph 606-10-55-44.

ASC 606-10-55-354

The points provide a material right to customers that they would not receive without entering into a

contract. Consequently, the entity concludes that the promise to provide points to the customer is a

performance obligation.

Customer loyalty program

Health Store sells various health products, including supplements, drink mixes, and food products. All

customers are eligible to participate in a loyalty program, with no cost of entry; however, customers

must enroll in the program to participate. Points earned on purchases can be redeemed for rewards,

such as gift cards or free products. Customers earn one point for every $1 spent on a product.

Health Store considers whether its loyalty program provides a material right to the customer that it would

not receive without entering into that contract (for example, a discount that is incremental to the range of

discounts typically given), as follows:

• Material right to the customer – Health Store concludes that the loyalty program drives customer

purchases because, as they earn more points, they have more opportunities to redeem points for a

TRG Paper 6, Customer options for additional goods and services and nonrefundable upfront fees.

TRG area of general agreement: Should the evaluation of whether an option provides a

material right be performed only in the context of the current transaction with a

customer?

At the October 2014 meeting,

the TRG generally agreed that an entity should consider “relevant”

transactions with the customer, meaning past, current, and future transactions, as well as both

quantitative and qualitative factors, including whether the right accumulates, when evaluating whether

an option provides a material right. As a result, the TRG agreed that generally, awarded credits or

points provided under accumulating award programs will give rise to a material right and should be

accounted for as a separate performance obligation to which a portion of the transaction price must be

allocated.

Identify the performance obligations in the contract 71

gift card or free product. Customers must take an extra step to opt into the program to participate,

which indicates the program is important to them.

• Incremental to the range of discounts typically given – The points are incremental to the range of

discounts typically given to customers that are not enrolled in the program. Therefore, the points are

incremental discounts to customers who purchase products and earn points.

Based on this analysis and consistent with the October 14 TRG discussion, Health Store concludes that

the points are a material right and therefore qualify as a separate performance obligation.

Tiered status program

Some entities offer tiered status programs that classify customers based on the total amount spent over a

specified period of time. Customers, depending on their tier, are entitled to incremental benefits, such as

a percentage of the amount spent as in-store credit, or discounted or free goods and services. Entities

with these types of tiered status programs need to evaluate whether the status benefits represent a

material right to the customer that is not available to other customers that have not qualified for tiered

status. If the tiered status benefit is a material right, it should be accounted for as a separate performance

obligation.

Entities, such as airlines or hospitality companies, may offer tiered status to existing or potential

customers that have otherwise not qualified for the tiered status to encourage future spending from these

customers. For example, a sponsoring entity may offer tiered status benefits for a limited time to certain

individuals based on their demographic information, such as job title, profession, or employer, with the

expectation that the individuals’ future spending will be consistent with the spending level associated with

that tier. If the sponsoring entity’s business practice is to provide the status benefit discounts to a

particular class of customer regardless of the customer’s past level of spending with the sponsoring

entity, the status benefits are a marketing incentive.

To determine whether a tiered status benefit is a marketing incentive or a material right, entities should

evaluate the total transactions of the customer over a period of time rather than a single transaction.

The table below lists factors that may indicate a tiered status benefit is a marketing incentive or a material

right and therefore a separate performance obligation).

Identify the performance obligations in the contract 72

Figure 4.5: Considering whether tiered status benefits are a material right

Indicators that tiered status

benefit is a marketing incentive

Indicators that tiered status

benefit is a material right

Tier status is provided to customers that have not

previously spent the qualifying amount.

The sponsoring entity sells tier status in exchange

for cash or customers who receive matched status

must achieve a higher level of qualifying activity in

the specific period than customers who earned

equivalent status.

Tier status is provided temporarily based on the

expectation that the customer will spend the

qualifying amount in the future equivalent with that

of individuals who earn tier status through past

revenue transactions with the entity and the entity

has a business practice of providing such

temporary tier status

The sponsoring entity expects a net loss from the

customer’s future spending and future discounts.

Tier status can be earned by spending with

unrelated entities that are marketing partners of

the entity (affinity programs) and that results in

little or no consideration to the entity sponsoring

the affinity program.

The option is transferrable by the customer to

others.

The exercise of a material right

ASC 606 does not contain explicit guidance on how an entity should account for a customer’s exercise of

a material right; however, as discussed by the TRG, the exercise of an option should not be accounted for

as variable consideration. Instead, the guidance seems to support two reasonable approaches:

• Account for the exercise of the option as a continuation of the existing contract (that is, by updating

the transaction price) (see Section 5.5)

• Account for the exercise of the option as a contract modification (see Section 10)

TRG area of general agreement: How should an entity account for the exercise of a

material right: as the continuation of the existing contract, as a contract modification,

or as variable consideration?

As noted above, the guidance seems to support accounting for the exercise of the option as either

• A continuation of the existing contract because the provision was contemplated as part of the

original contract, as evidenced by a portion of the transaction price being allocated to the customer

option as a separate performance obligation

Identify the performance obligations in the contract 73

• A contract modification because any additional consideration or any additional goods/services

provided upon the exercise of the customer option could be viewed as a change in the price and

scope of the contract

At the March 2015 meeting,

the TRG agreed that the exercise of an option should not be accounted

for as variable consideration because, as the Boards made clear in BC186 of ASU 2014-09, the

transaction price should only include amounts to which the entity has rights under the present contract,

and should not include estimates of consideration from the future exercise of options for additional

goods or services or from future change orders.

4.5 Nonrefundable upfront fees

Many contracts require a customer to pay a nonrefundable fee at or near contract inception. For example,

health clubs often charge joining fees, telecommunication entities may charge activation fees, and service

providers frequently charge setup fees.

When a customer is required to make a nonrefundable upfront payment, an entity must determine

whether the activity associated with the fee results in the transfer of a promised good or service. In many

cases, the fee relates to a necessary activity of the entity; however, that activity does not result in the

transfer of a promised good or service to the customer.

When an upfront fee does not relate to the transfer of a promised good or service, the fee is an advance

payment for future goods or services and the entity should recognize the fee as revenue when the future

goods or services are provided. In addition, the entity should determine whether the upfront fee provides

the customer with an option for additional goods or services that represents a material right.

ASC 606-10-25-17

Promised goods or services do not include activities that an entity must undertake to fulfill a contract

unless those activities transfer a good or service to a customer. For example, a services provider may

need to perform various administrative tasks to set up a contract. The performance of those tasks does

not transfer a service to the customer as the tasks are performed. Therefore, those setup activities are

not promised goods or services in the contract with the customer.

ASC 606-10-55-50

In some contracts, an entity charges a customer a nonrefundable upfront fee at or near contract

inception. Examples include joining fees in health club membership contracts, activation fees in

telecommunications contracts, setup fees in some services contracts, and initial fees in some supply

contracts.

ASC 606-10-55-51

To identify performance obligations in such contracts, an entity should assess whether the fee relates

to the transfer of a promised good or service. In many cases, even though a nonrefundable upfront fee

relates to an activity that the entity is required to undertake at or near contract inception to fulfill the

contract, that activity does not result in the transfer of a promised good or service to the customer (see

paragraph 606-10-25-17). Instead, the upfront fee is an advance payment for future goods or services

TRG Paper 32, Accounting for a Customer’s Exercise of a Material Right.

Identify the performance obligations in the contract 74

and, therefore, would be recognized as revenue when those future goods or services are provided. The

revenue recognition period would extend beyond the initial contractual period if the entity grants the

customer the option to renew the contract and that option provides the customer with a material right

as described in paragraph 606-10-55-42.

ASC 606-10-55-52

If the nonrefundable upfront fee relates to a good or service, the entity should evaluate whether to

account for the good or service as a separate performance obligation in accordance with paragraphs

606-10-25-14 through 25-22.

ASC 606-10-55-53

An entity may charge a nonrefundable fee in part as compensation for costs incurred in setting up a

contract (or other administrative tasks as described in paragraph 606-10-25-17). If those setup

activities do not satisfy a performance obligation, the entity should disregard those activities (and

related costs) when measuring progress in accordance with paragraph 606-10-55-21. That is because

the costs of setup activities do not depict the transfer of services to the customer. The entity should

assess whether costs incurred in setting up the contract have resulted in an asset that should be

recognized in accordance with paragraph 340-40-25-5.

ASC 606, Example 53, illustrates the guidance for nonrefundable upfront fees.

Example 53—Nonrefundable Upfront Fee

ASC 606-10-55-358

An entity enters into a contract with a customer for one year of transaction processing services. The

entity’s contracts have standard terms that are the same for all customers. The contract requires the

customer to pay an upfront fee to set up the customer on the entity’s systems and processes. The fee is

a nominal amount and is nonrefundable. The customer can renew the contract each year without paying

an additional fee.

ASC 606-10-55-359

The entity’s setup activities do not transfer a good or service to the customer and, therefore, do not give

rise to a performance obligation.

ASC 606-10-55-360

The entity concludes that the renewal option does not provide a material right to the customer that it

would not receive without entering into that contract (see paragraph 606-10-55-42). The upfront fee is,

in effect, an advance payment for the future transaction processing services. Consequently, the entity

determines the transaction price, which includes the nonrefundable upfront fee, and recognizes revenue

for the transaction processing services as those services are provided in accordance with paragraph

606-10-55-51.

Identify the performance obligations in the contract 75

Figure 4.5: Nonrefundable upfront fees

TRG area of general agreement: Over what period should an entity recognize a

nonrefundable upfront fee?

The TRG discussed the following example at the March 2015 meeting

An entity charges a one-time $50 activation fee to a customer that enters into a month-to-

month contract for a price of $100 per month.

The entity concludes that the activation fee charged for signing up the customer does not result in the

transfer of a good or service to the customer, and therefore it does not represent an additional

promised service in the contract. Rather, the activation fee represents an advance payment for the

entity’s services and should be deferred and recognized as the future services are provided.

When considering the period over which the activation fee should be recognized, the entity considers

whether the activation fee provides the customer with a material right with respect to renewing the

entity’s services. In making this determination, the entity considers both quantitative and qualitative

factors, for example:

• Whether the renewal price ($100 per month) compared with the price a new customer would pay

for the same service ($100 per month + $50 activation fee = $150) provides the customer with a

material right

TRG Paper 32, Accounting for a Customer’s Exercise of a Material Right.

Does the fee relate to the transfer of a

promised good or service?

Recognize the fee, which is an

advance payment for future goods

or services when those future

goods or services are provided.

(ASC 606-10-55-51)

Evaluate whether to account for the

good or service as a separate

performance obligation.

(ASC 606-10-25-14 through 25-22)

Disregard the setup activities

when measuring progress because

the costs do not depict the transfer of

goods or services to the customer.

(ASC 606-10-55-21)

Include the activities when

measuring progress if not a

separate performance obligation.

(ASC 606-10-55-21)

Identify the performance obligations in the contract 76

• Availability and pricing of service alternatives (for example, can the customer obtain substantially

equivalent services from another provider without paying an activation fee)

• Average customer lifespan (if the average customer lifespan extends well beyond the one-month

contractual period, this may be an indication that the activation fee incentivizes customers to

continue services)

If the entity concludes that the activation fee provides a material right, the entity would recognize the

fee over the service periods during which the customer is expected to benefit from not having to pay

the activation fee upon renewal of the service. Determining this period will require judgment.

On the other hand, if the entity concludes that the activation fee does not provide the customer with a

material right, the activation fee is, in effect, an advance payment solely on the contracted services.

Therefore, the entity would recognize the fee as part of the overall transaction price as revenue as

those services are provided in the first month.

One possible indication that a renewal option constitutes a material right is when an entity requires an

initial up-front fee, but subsequent contract renewals require a reduced fee or no fee. If an entity

determines that the renewal option provides the customer with a material right, it must identify that option,

and not the underlying services, as a separate performance obligation. The entity should account for the

material right as a performance obligation by estimating the stand-alone selling price of the renewal

option and allocating a portion of the overall transaction price to the option.

Initial nonrefundable up-front fee and renewal options

On January 1, 20X8, Franchisor, a public company, enters into a franchise license agreement with

Franchisee, and Franchisee pays an initial, nonrefundable fee of $30,000 to Franchisor. Franchisee

receives a five-year license to operate a franchise location, including access to trademarks and the right

to use proprietary operating methodologies and procedures. Before and during the opening of

Franchisee’s store, Franchisor performs certain setup activities, such as approving the store location,

providing access to architectural plans and other store specifications, and assisting with the on-site

opening activities. Franchisee may renew the license agreement for one additional five-year term. A

nonrefundable fee of 10 percent of the initial license fee is due at renewal.

Franchisor considers whether the promised start-up activities transfer a good or service to Franchisee

and concludes that the start-up activities alone do not transfer a benefit to Franchisee but are instead

part of granting access to the franchise rights. Because Franchisor is a public company, it does not

qualify to apply the practical expedient in ASC 952-606-25-2 and must therefore evaluate the start-up

activities under the ASC 606 model.

Franchisor also considers whether the option to renew for an additional five-year term includes a

discount that is a material right. Because Franchisee may renew the agreement for only 10 percent of

the initial franchise fee, Franchisor concludes that the renewal option provides a material right to

Franchisee.

Franchisor determines that the agreement contains two performance obligations: the franchise license

and the renewal option. Franchisor allocates the initial fee of $30,000 to those performance obligations

on a relative stand-alone selling price basis. Revenue for the franchise license is recognized over the

term of the franchise agreement, while the amount allocated to the renewal option is recorded as a

Identify the performance obligations in the contract 77

contract liability and recognized as revenue either over the renewal term if the option is exercised or

when the renewal option expires.

Private franchisor practical expedient

The amendments in ASU 2021-02 introduce a practical expedient for franchisors that are not public

business entities. Under the expedient, qualifying entities may account for pre-opening services provided

to a franchisee as distinct from the franchise license if the services are included in a predefined list set

forth within the amendments, which is codified in ASC 952-606-25-2. Franchisors adopting the practical

expedient may make an accounting policy election to account for qualifying pre-opening services as a

single performance obligation. Franchisors must disclose when they use the practical expedient and

make the accounting policy election to recognize the pre-opening services as a single performance

obligation.

Franchisors that do not elect the practical expedient need to apply Step 2 of the revenue model in ASC

606 to identify the performance obligations in their franchise agreements. Under Step 2, franchisors need

to analyze pre-opening activities (such as site selection and training of the franchisee’s personnel) in their

arrangements to assess whether the activities represent promised goods or services and, if so, to

determine whether the promises are distinct from one another and should be accounted for as separate

performance obligations. Under ASC 606, an entity must determine and then allocate the transaction

price among the distinct performance obligations in an arrangement on a relative stand-alone selling price

basis.

ASC 952-606-25-2

As a practical expedient, when applying the guidance in Topic 606, a franchisor that enters into a

franchise agreement may account for the following pre-opening services as distinct from the franchise

license:

a. Assistance in the selection of a site

b. Assistance in obtaining facilities and preparing the facilities for their intended use, including related

financing, architectural, and engineering services, and lease negotiation

c. Training of the franchisee’s personnel or the franchisee

d. Preparation and distribution of manuals and similar material concerning operations, administration,

and record keeping

e. Bookkeeping, information technology, and 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

f. Inspection, testing, and other quality control programs.

ASC 952-606-25-3

A franchisor that elects the practical expedient in paragraph 952-606-25-2 shall apply the guidance in

paragraphs 606-10-25-19 through 25-22 to determine whether the pre-opening services are distinct

Identify the performance obligations in the contract 78

Applying the private franchisor practical expedient

Franchisor A enters into a contract with a customer (a franchisee) and promises to grant a franchise

license to operate a hotel for 10 years. In addition to the license, Franchisor A also promises to provide

site selection services and training to the franchisee.

Franchisor A determines that it is eligible to apply the practical expedient since it is not a public business

entity and falls within the scope of ASC 952. Next, Franchisor A determines that its pre-opening services

(training and site selection) are included within the list of qualifying services in ASC 952-606-25-2 to

apply the practical expedient. As a result, Franchisor A elects to account for the services as distinct from

the franchise license and also makes an accounting policy election to account for all qualifying pre-

opening services as a single performance obligation. Franchisor A concludes that it has two distinct

performance obligations in this arrangement: a franchise license and pre-opening services.

Franchisor A applies the guidance in ASC 606 to determine the transaction price, to allocate the

transaction price to the two separate performance obligations, and to recognize revenue when or as it

transfers control of the related performance obligations to the franchisee.

Finally, Franchisor A discloses its use of the practical expedient and policy election in the notes to the

financial statements.

4.6 Warranties

ASC 606 contains guidance for the accounting for warranties. If a customer has the option to separately

purchase a warranty, then an entity accounts for that warranty as a separate performance obligation. If a

customer does not have the option to separately purchase a warranty, then the entity accounts for the

warranty using the guidance on product warranties in ASC 460-10, unless all or part of the warranty

provides the customer with an “additional service” beyond the assurance that the product complies with

agreed-upon specifications.

ASC 606-10-55-30

It is common for an entity to provide (in accordance with the contract, the law, or the entity’s customary

business practices) a warranty in connection with the sale of a product (whether a good or service).

The nature of a warranty can vary significantly across industries and contracts. Some warranties

from one another unless it makes an accounting policy election to account for the pre-opening services

as a single performance obligation.

ASC 952-606-25-4

The practical expedient in paragraph 952-606-25-2 applies only to identifying performance obligations.

An entity shall apply this guidance consistently to contracts with similar characteristics and in similar

circumstances. An entity should see Topic 606 for guidance on the remaining aspects of recognizing

revenue from contracts with customers, including allocating the transaction price and recognizing

revenue. If an entity elects not to apply the practical expedient or if the services performed are not

consistent with the list in paragraph 952-606-25-2, the entity shall apply the guidance in Topic 606 on

identifying performance obligations.

Identify the performance obligations in the contract 79

provide a customer with assurance that the related product will function as the parties intended

because it complies with agreed-upon specifications. Other warranties provide the customer with a

service in addition to the assurance that the product complies with agreed-upon specifications.

ASC 606-10-55-31

If a customer has the option to purchase a warranty separately (for example, because the warranty is

priced or negotiated separately), the warranty is a distinct service because the entity promises to

provide the service to the customer in addition to the product that has the functionality described in the

contract. In those circumstances, an entity should account for the promised warranty as a performance

obligation in accordance with paragraph 606-10-25-14 through 25-22 and allocate a portion of the

transaction price to that performance obligation in accordance with paragraphs 606-10-32-28 through

32-41.

ASC 606-10-55-32

If a customer does not have the option to purchase a warranty separately, an entity should account for

the warranty in accordance with the guidance on product warranties in Subtopic 460-10 on guarantees,

unless the promised warranty, or a part of the promised warranty, provides the customer with a service

in addition to the assurance that the product complies with agreed-upon specifications.

ASC 606-10-55-33

In assessing whether a warranty provides a customer with a service in addition to the assurance that

the product complies with agreed-upon specifications, an entity should consider factors such as:

a. Whether the warranty is required by law—If the entity is required by law to provide a warranty, the

existence of that law indicates that the promised warranty is not a performance obligation because

such requirements typically exist to protect customers from the risk of purchasing defective

products.

b. The length of the warranty coverage period—The longer the coverage period, the more likely it is

that the promised warranty is a performance obligation because it is more likely to provide a

service in addition to the assurance that the product complies with agreed-upon specifications.

c. The nature of the tasks that the entity promises to perform—If it is necessary for an entity to

perform specified tasks to provide the assurance that a product complies 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.

ASC 606-10-55-34

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 is a performance

obligation. Therefore, an entity should allocate the transaction price to the product and the service. If an

entity promises both an assurance-type warranty and a service-type warranty but cannot reasonably

account for them separately, the entity should account for both of the warranties together as a single

performance obligation.

ASC 606-10-55-35

A law that requires an entity to pay compensation if its products cause harm or damage does not give

rise to a performance obligation. For example, a manufacturer might sell products in a jurisdiction in

which the law holds the manufacturer liable for any damages (for example, to personal property) that

Identify the performance obligations in the contract 80

might be caused by a consumer using a product for its intended purpose. Similarly, an entity’s promise

to indemnify the customer for liabilities and damages arising from claims of patent, copyright,

trademark, or other infringement by the entity’s products does not give rise to a performance obligation.

The entity should account for such obligations in accordance with the guidance on loss contingencies

in Subtopic 450-20 on contingencies.

Figure 4.7: Warranties

ASC 606-10-55-33 lists the following factors that an entity should consider in determining whether a

warranty provides a customer with an “additional service.”

Figure 4.8: Factors for evaluating warranties

Factor

Description

Whether the warranty

is required by law

A legal requirement to provide a warranty indicates that the warranty is

intended to protect the customer from purchasing a defective product.

Term of the warranty

coverage period

The longer the coverage period, the more likely it is that the promised warranty

includes a performance obligation because it is more likely to provide a service

in addition to the assurance that the product complies with

agreed-upon specifications.

Does the customer have the option to

separately purchase a warranty?

(ASC 606-10-55-31)

Does all or part of the warranty provide the

customer with an additional service beyond the

assurance that the product will comply

with agreed-upon specifications?

(ASC 606-10-55-32 through 55-35)

Account for the warranty as a

performance obligation.

Account for the service as a

separate performance obligation.

Account for the warranty using the

guidance in ASC 460.

Identify the performance obligations in the contract 81

Factor

Description

The nature of the

tasks the entity

promises to perform

under the warranty

If an entity must perform certain tasks to provide assurance to the customer

that the product complies with agreed-upon specifications, those services

would not likely constitute a separate performance obligation.

The guidance clarifies that the following situations do not give rise to a performance obligation:

• A law that requires the entity to compensate the customer for harm or damage caused by its products

when used by the customer for its intended purpose

• An entity’s promise to indemnify the customer for liabilities and damages arising from claims of

patent, copyright, trademark, or other infringement by the entity’s products

An entity accounts for such obligations in accordance with the guidance on loss contingencies in

ASC 450-20.

Evaluating warranties

A manufacturing entity provides a two-year warranty and an extended five-year warranty to repair any of

its products free of charge. The entity does not separately sell the warranties. The entity considers the

following three factors when evaluating the warranties to determine if they provide an additional service:

1. Whether the warranty is required by law – No law exists that requires the manufacturing entity to

provide a warranty.

2. Term of the warranty coverage period – The entity considers the two-year warranty to be its

standard warranty coverage period based on its product offering and the estimated life of its

products. The entity considers the five-year warranty to be extended warranty coverage. Because

the estimated life of the product does not exceed two years, the entity expects to perform an

additional service for those customers that purchase the five-year warranty.

3. The nature of the tasks the entity promises to perform under the warranty – The entity agrees to

repair products that do not meet agreed-upon specifications. The entity also agrees to repair any

products broken or damaged by the customer.

After evaluating the factors provided in the guidance, the entity concludes that its two-year warranty

does not provide its customers with an additional service, while its five-year warranty does provide its

customers with an additional service. As a result, the entity accounts for the first two years of its five-

year warranty using the cost accrual guidance and the remaining three years as a separate

performance obligation.

5. Determine the transaction price

After identifying the contract in Step 1 (Section 3) and the performance obligations in Step 2 (Section 4),

an entity next applies Step 3 to determine the transaction price of the contract. The objective of Step 3 is

to predict the total amount of consideration to which the entity will be entitled from the contract. The

transaction price may include fixed amounts (for example, a fixed price of $10,000 for a single machine),

variable amounts (for example, $10 per part, but an unknown quantity of parts), or both fixed and variable

amounts. An entity estimates the transaction price at contract inception and updates the estimate each

reporting period to reflect changes in facts and circumstances.

ASC 606-10-32-2

An entity shall consider the terms of the contract and its customary business practices to determine the

transaction price. 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, excluding amounts

collected on behalf of third parties (for example, some sales taxes). The consideration promised in a

contract with a customer may include fixed amounts, variable amounts, or both.

For purposes of determining the transaction price, an entity assumes that the goods or services promised

in the existing contract will be transferred to the customer. That is, the entity assumes that the contract

will not be cancelled, renewed, or modified; therefore, the transaction price includes only those amounts

to which the entity has rights under the present contract. For example, if an entity enters into a contract

with a customer that has an original term of one year and the entity expects the customer to renew for a

second year, the entity would determine the transaction price based on the one-year original term.

ASC 606-10-32-4

For the purpose of determining the transaction price, an entity shall assume that the goods or services

will be transferred to the customer as promised in accordance with the existing contract and that the

contract will not be cancelled, renewed, or modified.

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, excluding amounts collected on

behalf of third parties.

Determine the transaction price 83

When determining the transaction price, an entity first identifies the fixed consideration, which includes

any nonrefundable upfront payment amounts. In addition to fixed consideration, an entity considers the

effects of the following components in determining the transaction price:

• Variable consideration and the constraint (Section 5.1)

• Significant financing components (Section 5.2)

• Noncash consideration (Section 5.3)

• Consideration payable to the customer (Section 5.4)

Each component is discussed in more detail below.

Figure 5.1: Components for determining the transaction price

5.1 Variable consideration

When a contract includes a variable amount, the entity estimates the amount of variable consideration to

which it expects to be entitled. After all, by definition, 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.

ASC 606-10-32-5

If the consideration promised in a contract includes a variable amount, an entity shall estimate the

amount of consideration to which the entity will be entitled in exchange for transferring the promised

goods or services to a customer.

Consideration payable

to customer

(Section 5.4)

Variable consideration

and the constraint

(Section 5.1)

Noncash consideration

(Section 5.3)

Significant financing

components

(Section 5.2)

Transaction price

Determine the transaction price 84

Variable consideration includes any consideration that is not fixed. In other words, the amount may

fluctuate as a result of the outcome of uncertain events. Common examples of variable consideration

include discounts, rebates, refunds, credits, price concessions, performance bonuses, and penalties. The

variability may be explicitly stated in the contract or implicit (for example, based on the entity’s business

practice, the customer has a valid expectation that the entity will accept an amount of consideration that is

less than the stated price in the contract). Variable consideration may be fixed in amount, but the entity’s

right to receive that consideration is contingent on a future outcome. For example, the amount of a

performance bonus might be fixed, but because the entity is not entitled to that bonus until a performance

target is met, the outcome is uncertain and therefore the amount is considered variable.

Price concessions

Price concessions may take the form of a discount, refund or credit, among others, and are a form of

variable consideration.

ASC 606-10-32-7

The variability relating to the consideration promised by a customer may be explicitly stated in the

contract. In addition to the terms of the contract, the promised consideration is variable if either of the

following circumstances exists:

a. 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 price stated in the contract. That is, it is expected that the entity will offer a price

concession. Depending on the jurisdiction, industry, or customer this offer may be referred to as a

discount, rebate, refund, or credit.

b. Other facts and circumstances indicate that the entity’s intention, when entering into the contract

with the customer, is to offer a price concession to the customer.

Under Step 1, an entity should distinguish between a price concession and collectibility. The inability to

collect the promised consideration might lead an entity to conclude that it does not pass Step 1, while a

price concession might result in variable consideration, allowing the entity to proceed to Step 2 with a

lower transaction price. See further discussion of distinguishing price concessions from collectibility

issues in Step 1 at Section 3.1.5.

ASC 606, Example 2, illustrates how an entity considers a price concession when determining if the

Step 1 criteria are met. It also demonstrates the interaction of the guidance in Steps 1 and 3, because the

entity needs to determine the transaction price (in this case, it is variable due to the price concession) in

order to determine if it is probable that the entity will collect substantially all of the consideration to which it

expects to be entitled, in accordance with ASC 606-10-25-1(e).

Example 2—Consideration is Not the Stated Price—Implicit Price Concession

ASC 606-10-55-99

An entity sells 1,000 units of a prescription drug to a customer for promised consideration of $1 million.

This is the entity’s first sale to a customer in a new region, which is experiencing significant economic

Determine the transaction price 85

difficulty. Thus, the entity expects that it will not be able to collect from the customer the full amount of

the promised consideration. Despite the possibility of not collecting the full amount, the entity expects

the region’s economy to recover over the next two to three years and determines that a relationship

with the customer could help it to forge relationships with other potential customers in the region.

ASC 606-10-55-100

When assessing whether the criterion in paragraph 606-10-25-1(e) is met, the entity also considers

paragraphs 606-10-32-2 and 606-10-32-7(b). Based on the assessment of the facts and

circumstances, the entity determines that it expects to provide a price concession and accept a lower

amount of consideration from the customer. Accordingly, the entity concludes that the transaction price

is not $1 million and, therefore, the promised consideration is variable. The entity estimates the variable

consideration and determines that it expects to be entitled to $400,000.

ASC 606-10-55-101

The entity considers the customer’s ability and intention to pay the consideration and concludes that

even though the region is experiencing economic difficulty it is probable that it will collect $400,000

from the customer. Consequently, the entity concludes that the criterion in paragraph 606-10-25-1(e) is

met based on an estimate of variable consideration of $400,000. In addition, based on an evaluation of

the contract terms and other facts and circumstances, the entity concludes that the other criteria in

paragraph 606-10-25-1 are also met. Consequently, the entity accounts for the contract with the

customer in accordance with this Topic.

Estimating the amount of variable consideration

If a contract includes a variable amount, an entity estimates the transaction price.

Grant Thornton insight: When an entity is not required to estimate variable

consideration

In limited situations, an entity may not be required to estimate the amount of variable consideration,

including when the entity

• Is permitted to apply the right-to-invoice practical expedient (Section 7.1.3.)

• Meets the allocation objective described in Section 6.5.1 and is required to allocate variable

consideration entirely to a distinct good or service that forms part of a series

• Is required to apply the “royalty exception” for a license of intellectual property (Section 8.5.)

The “royalty exception” provides relief from estimating and constraining variable consideration when

the variability relates to consideration tied to the sales and usage of intellectual property; however, the

“royalty exception” does not completely absolve the entity from all estimations.

For example, some pharmaceutical manufacturers receive sales reports from their distributors on a

quarterly basis, and the manufacturers use these reports, which summarize sales by product and

geography, to recognize revenue. Often, these reported numbers include critical estimates, such as

sales rebates and product returns. The manufacturer should consider whether the estimates in the

reported sales data are reasonable or if they require any further adjustments. See Section 8.5 for

Determine the transaction price 86

additional information and an example illustrating the factors an entity may consider in refining its

estimate.

To estimate the variable consideration in a contract, an entity determines either the expected value or the

most likely amount of consideration to be received, depending on which method better predicts the

amount to which the entity will be entitled. In other words, the selection of a method to estimate the

variable consideration is not a free choice or an accounting policy election.

ASC 606-10-32-8

An entity shall estimate an amount of variable consideration by using either of the following methods,

depending on which method the entity expects to better predict the amount of consideration to which it

will be entitled:

a. The expected value – The expected value is the sum of probability-weighted amounts in a range of

possible consideration amounts. An expected value may be an appropriate estimate of the amount

of variable consideration if an entity has a large number of contracts with similar characteristics.

b. The most likely amount – The most likely amount is the single most likely amount in a range of

possible consideration amounts (that is, the single most likely outcome of the contract). The most

likely amount may be an appropriate estimate of the amount of variable consideration if the

contract has only two possible outcomes (for example, an entity either achieves a performance

bonus or does not).

Grant Thornton insight: Selecting the best method for estimating variable

consideration

As stated in ASC 606-10-32-8, the “expected value” of consideration is the sum of probability-weighted

amounts in a range of possible amounts. Therefore, if an entity utilizes an expected value approach to

estimate the amount of consideration that it expects to be entitled to, we believe that management

should support this assertion by demonstrating its use of probability weighting for the identified

outcomes.

While ASC 606 says the “most likely amount” may be an appropriate estimate of variable consideration

for contracts with only two possible outcomes, we believe this method may also be appropriate in other

circumstances. For example, some entities track their customers’ historical returns or rebates to

support their estimate of variable consideration. In other words, an entity might be able to demonstrate

that its customers’ historical data best predicts the “most likely amount” it expects to be entitled to in

the future. Because the objective of Step 3 in the revenue model is to estimate the amount of

consideration to which the entity expects to be entitled to in exchange for transferring the promised

goods or services, we believe that some entities could achieve this objective, in part, by utilizing

historical data while also considering whether any adjustments are needed to the historical data based

on other available information.

Determine the transaction price 87

An entity uses the same method to estimate the variable consideration throughout the life of a contract;

however, the Boards note in BC202 of ASU 2014-09 that this does not mean that an entity needs to use

one method to measure each uncertainty in a single contract. Instead, an entity may use different

methods for different uncertainties in a single contract.

ASC 606-10-32-9

An entity shall apply one method consistently throughout the contract when estimating the effect of an

uncertainty on an amount of variable consideration to which the entity will be entitled. In addition, an

entity shall consider all the information (historical, current, and forecast) that is reasonably available to

the entity and shall identify a reasonable number of possible consideration amounts. The information

that an entity uses to estimate the amount of variable consideration typically would be similar to the

information that the entity’s management uses during the bid-and-proposal process and in establishing

prices for promised goods or services.

The following example demonstrates the application of the expected value and most likely amount

approaches when estimating the amount of variable consideration in a contract.

Estimating variable consideration

Construction Co. enters into a contract with a customer to build a manufacturing facility. The entity

determines that the contract contains one performance obligation satisfied over time.

Construction is scheduled to be completed by the end of the eighteenth month for an agreed-upon price

of $25 million.

The entity has the opportunity to earn a performance bonus for early completion as follows:

• 15 percent bonus of the $25 million contract price if completed by the fifteenth month (20 percent

likelihood)

• 10 percent bonus if completed by the sixteenth month (50 percent likelihood)

• 5 percent bonus if completed by the seventeenth month (20 percent likelihood)

In addition to the potential performance bonus for early completion, Construction Co. is entitled to a

quality bonus of $2 million if a health and safety inspector assigns the facility a gold star rating as

defined by the agency in the terms of the contract. Construction Co. concludes that it is 80 percent likely

that it will receive the quality bonus.

In determining the transaction price, Construction Co. separately estimates variable consideration for

each element of variability: the early completion bonus and the quality bonus.

Construction Co. decides to use the expected value method to estimate the variable consideration

associated with the early completion bonus because there is a range of possible outcomes and the

entity has experience with a large number of similar contracts that provide a reasonable basis to predict

future outcomes.

Determine the transaction price 88

Drawing from its past experience, Construction Co. identifies the following factors that could impact its

ability to predict when the manufacturing facility will be completed:

• Completing projects with similar requirements in the same geographic region

• Working with the same subcontractors who completed similar construction projects ahead of

schedule

• Relying on the same suppliers

• Performing in similar weather conditions

Therefore, the entity expects this method to best predict the amount of variable consideration

associated with the early completion bonus. Construction Co.’s best estimate of the early completion

bonus is $2.250 million, calculated as shown in the following table.

Possible bonus

outcomes

Probability

Probability-weighted

amount

$3,750,000

20%

$ 750,000

$2,500,000

50%

$1,250,000

20%

$ 250,000

$ 0

10%

$ 0

$2,250,000

Construction Co. decides to use the most likely amount to estimate the variable consideration

associated with the potential quality bonus because there are only two possible outcomes ($2 million or

$0) and this method would best predict the amount of consideration associated with the quality bonus.

Construction Co. believes the most likely amount of the quality bonus is $2 million.

The entity next considers the guidance on constraining the estimates of variable consideration

(Section 5.1.1) to determine whether it should include some or all of the estimates of variable

consideration in the transaction price.

Grant Thornton insight: Estimating variable consideration using multiple methods in a

single contract

As noted in BC202 of ASU 2014-09 and in ASC 606-10-32-9, the Boards decided that an entity may

use different methods to estimate variable consideration in a contract with multiple uncertainties;

Determine the transaction price 89

however, once an entity selects its estimation method for a particular uncertainty, it must continue to

apply that method for the duration of the contract.

While we acknowledge that an entity may apply different methods for different uncertainties, we believe

entities should apply similar estimation methods to similar uncertainties across their portfolio of

revenue contracts.

The Boards acknowledged

that applying the expected value method using a probability-weighted

method does not require an entity to consider all possible outcomes because, in many cases, using a

limited number of discrete outcomes and probabilities provides a reasonable estimate of the distribution

of possible outcomes. Nonetheless, in order to use the expected value method, the entity should have a

sufficient volume of similar transactions or other reliable data.

A sufficient volume of similar transactions might exist if an entity has a large volume of customer contracts

for the same good or service; however, an entity is not strictly required to have a population of

homogeneous transactions to apply the expected value method. In the example above, while the

construction company has only one customer contract for this specific manufacturing facility, it may apply

the expected value method to estimate the early performance bonus because it has a sufficient volume of

historical customer contracts where similar factors impacted its ability to achieve the early performance

bonus.

At the July 2015 meeting,

most TRG members agreed that the estimated transaction price determined

using the expected value method can be an amount that is not a possible outcome of an individual

contract. As an entity updates its estimate of variable consideration at the end of each reporting period

(Section 5.1.6), the expected value will converge toward a possible outcome.

Entities may experience difficulty estimating the transaction price when little or no entity-specific data

exists. The discussion below includes examples of other reliable data that may be used in such situations.

Grant Thornton insight: Estimating variable consideration using the expected value

method when no entity-specific data exists

If an entity lacks a population of similar contracts, it would be inappropriate to default to zero as the

amount of estimated variable consideration for a single customer contract. Instead, entities should

make a good faith effort to estimate the amount of variable consideration based on the available

information, including

• Industry data for similar products or services (for example, competitor contracts in the same

market)

• Information used internally in the bid and proposal process, such as in negotiating the sales price

• Data used internally in the product development process (for example, market studies)

• Information shared with external stakeholders

BC201, ASU 2014-09.

TRG Paper 38, Portfolio Practical Expedient and Application of Variable Consideration Constraint.

Determine the transaction price 90

When an entity estimates variable consideration using the expected value method, we believe it is

unlikely that the amount of variable consideration would be zero. While an entity may consider variable

consideration of zero as one of the possibilities since the expected value method is based on a

probability-weighting of multiple possible outcomes, we expect that the estimated variable

consideration under this method would be greater than zero.

Entities may also question whether variable consideration should be constrained to zero when no

entity-specific data exists. To meet the objective of the constraint guidance (see Section 5.1.1), an

entity assesses whether it is probable that changes in its estimate of variable consideration will not

result in a significant downward adjustment to the cumulative amount of revenue recognized on the

contract. An entity may include some or all of an estimate of variable consideration in the transaction

price, but only to the extent it is probable that a significant revenue reversal will not occur.

While entities should carefully apply the constraint guidance, entities generally enter into revenue

contracts with customers with the expectation of earning a profit. Accordingly, we do not expect

variable consideration to be constrained to zero solely due to lack of entity-specific data.

When a contract’s consideration is primarily variable, if the consideration is constrained to zero this

may call into question whether the criteria to establish a contract were met, in particular, whether the

contract has commercial substance.

Constraint on variable consideration

If an amount of consideration in a customer contract is variable, an entity evaluates whether to constrain

the amount of estimated variable consideration. The objective of the constraint is for an entity to

recognize revenue only to the extent it is probable that a significant reversal in cumulative revenue

recognized for the contract will not occur when the uncertainty is resolved. In other words, an entity

includes some or all of its estimate of variable consideration in the transaction price to the extent that it is

probable that a significant revenue reversal will not occur when the uncertainty leading to the variability is

resolved.

Figure 5.2: Variable consideration and the constraint

Estimate variable consideration

(Section 5.1)

Apply the constraint guidance

(Section 5.1.1)

Expected

value

Most likely

amount

Limit to the amount at

which it is probable

that there will not be a

significant revenue reversal.

Determine the transaction price 91

ASC 606-10-32-11

An entity shall include in the transaction price some or all of an amount of variable consideration

estimated in accordance with paragraph 606-10-32-8 only to the extent that it is probable that a

significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty

associated with the variable consideration is subsequently resolved.

To meet the objective of the constraint guidance, an entity assesses whether it is “probable” (meaning the

future event or events are likely to occur) that changes in the entity’s estimate of variable consideration

will not result in a significant downward adjustment to the cumulative amount of revenue recognized on

the contract. In making this assessment, an entity considers all of the facts and circumstances associated

with both the likelihood and the magnitude of the reversal if that uncertain event were to occur or fail to

occur.

The Boards stated

that the analysis an entity undertakes to determine whether its estimate meets the

“probable” threshold is largely qualitative and requires judgment. The evaluation also requires an entity to

consider both the likelihood and the magnitude of the potential revenue reversal.

ASC 606-10-32-12 includes factors that might increase the likelihood of a significant revenue reversal if

an entity includes an estimate of variable consideration in the transaction price.

ASC 606-10-32-12

In assessing whether it is probable that a significant reversal in the amount of cumulative revenue

recognized will not occur once the uncertainty related to the variable consideration is subsequently

resolved, an entity shall consider both the likelihood and the magnitude of the revenue reversal.

Factors that could increase the likelihood or magnitude of a revenue reversal include, but are not

limited to, any of the following:

a. The amount of consideration is highly susceptible to factors outside the entity’s influence. Those

factors may include volatility in a market, the judgment or actions of third parties, weather

conditions, and a high risk of obsolescence of the promised good or service.

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

of time.

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

experience (or other evidence) has limited predictive value.

d. The entity has a practice of either offering a broad range of price concessions or changing the

payment terms and conditions of similar contracts in similar circumstances.

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

BC212, ASU 2014-09.

Determine the transaction price 92

When determining the transaction price, an entity applies the constraint guidance at the contract level,

rather than at the performance obligation level, before allocating the amounts to individual performance

obligations. The TRG discussed which unit of account to use (that is, contract versus performance

obligation) at its January 2015 meeting.

Determine the transaction price 93

TRG area of general agreement: Should the constraint be applied at the contract or

performance obligation level?

ASC 606-10-32-11 states that an entity should include in the transaction price some or all of an amount

of variable consideration, but only to the extent that it is probable that a significant reversal in the

amount of cumulative revenue recognized will not occur when the uncertainty associated with the

variable consideration is subsequently resolved. While the guidance does not specify at which level the

assessment should take place (that is, at the contract level or at the performance obligation level), the

guidance might be read to suggest that the assessment takes place at the performance obligation

level.

At its January 2015 meeting,

TRG members generally agreed with the FASB and IASB staff that the

unit of account for determining the transaction price is the contract and not the performance obligation.

While the guidance does not explicitly address the unit of account for the constraint guidance, the BC

does state that the unit of account for other considerations in Step 3, namely identifying a significant

financing component, is the contract level. Therefore, the TRG and staff generally agreed that entities

should apply the constraint guidance at the contract level.

While it seems like a two-step process to estimate the transaction price and then to consider the

constraint guidance, the entity’s process to estimate the transaction price may already incorporate

considerations for the constraint so that the entity may accomplish the two steps in one.

The following example illustrates how an entity might apply the constraint guidance.

Applying the constraint guidance

Consider the same facts outlined in the example of estimating variable consideration in Section 5.1

above.

Construction Co. considers the factors that might signify a significant revenue reversal when

determining whether it should include in the transaction price all or a portion of the estimated variable

consideration for the early completion bonus of $2.250 million and the quality bonus of $2 million. The

evaluation of whether the bonus amounts should be constrained requires judgment, and the entity may

evaluate each bonus separately.

Construction Co. considers the following factors

• The project is sufficiently similar to past projects and Construction Co. has significant experience in

building facilities in compliance with health and safety regulations, consistently receiving gold-star

ratings.

BC216 and 217, ASU 2014-09.

TRG Paper 14, Variable Consideration.

BC234, ASU 2014-09.

Determine the transaction price 94

• The ratings align with objective criteria that the entity understands, and its completed projects

routinely comply with the objective criteria.

Based on its facts and circumstances, Construction Co. concludes it is probable that a significant

reversal in the cumulative amount of revenue recognized related to the quality bonus will not occur.

With respect to the early completion bonus, the entity may conclude that it is probable that a significant

reversal in the cumulative amount of revenue recognized will not occur when the uncertainty is resolved

(that is, when the project is finalized) if

• The entity has a significant history in building this type of facility in this geographic area, and there

are no additional risks associated with this project that would render this historical experience

irrelevant.

• Progress is highly dependent upon favorable weather conditions at certain points during the year,

but, after reviewing the historical temperature and rainfall for the period of work, the entity concludes

that there should be minimal disruptions.

• The entity does not have a practice of offering a broad range of price concessions or changing the

payment terms for similar contracts in the past.

On the other hand, the entity may determine that it cannot include all or a portion of the estimated

variable consideration in the transaction price related to the early completion bonus because it cannot

conclude that it is probable that a significant reversal in the cumulative amount of revenue recognized

will not occur. This may be the case if the building project is highly susceptible to factors outside the

entity’s influence. For instance, the construction may be highly susceptible to delays due to adverse

weather or the entity may rely extensively on third-party contractors to carry out its work.

Volume discounts

Tiered pricing clauses or volume discounts (hereafter referred to as “volume discounts”) are common in

customer contracts. In accordance with these types of clauses, the price per good or unit of service

changes (usually decreases) as the customer purchases an increased volume of goods or services. For

example, an entity sells the first 1,000 units to a customer at $100 per unit, but any purchases in excess

of 1,000 units are invoiced at $90 per unit. The accounting for volume discounts depends upon whether

the volume discount results in retrospective price changes or only in prospective price changes.

Retrospective volume discounts

Contracts that include retrospective volume discounts include variable consideration because the

transaction price depends upon the total volume of purchases by the customer. An entity accounts for

these arrangements in a manner similar to rebates. That is, the entity estimates the expected volume of

total purchases, uses the corresponding pricing, and considers the constraint guidance when determining

the transaction price for contracts that include retrospective volume discounts. In the example in the

preceding paragraph, contract pricing is $100 per unit, but the pricing is retrospectively reduced to $90

per unit if the customer purchases more than 1,000 units in the calendar year. In this case, if the entity

estimates that purchases will exceed 1,000 units, it uses $90 per unit as the transaction price and, for

each unit billed at $100, recognizes $10 per unit as a refund liability because it expects to have to refund

that amount to the customer.

If an entity cannot reasonably estimate the total quantity of goods or services that the customer will

purchase, it should use the minimum price per unit to determine the transaction price at inception, which

Determine the transaction price 95

is consistent with the constraint guidance. To include a higher price per unit in determining the transaction

price could result in a significant revenue reversal if the customer ultimately purchases sufficient volume

to achieve the minimum price per unit. As better information becomes available throughout the life of the

contract, the entity updates its estimated transaction price.

Example 24 from ASC 606 illustrates the accounting for a retrospective volume discount.

Example 24—Volume Discount Incentive

ASC 606-10-55-216

An entity enters into a contract with a customer on January 1, 20X8 to sell Product A for $100 per unit.

If the customer purchases more than 1,000 units of product A in a calendar year, the contract specifies

that the price per unit is retrospectively reduced to $90 per unit. Consequently, the consideration in the

contract is variable.

ASC 606-10-55-217

For the first quarter ended March 31, 20X8, the entity sells 75 units of Product A to the customer. The

entity estimates that the customer’s purchases will not exceed the 1,000-unit threshold required for the

volume discount in the calendar year.

ASC 606-10-55-218

The entity considers the guidance in paragraphs 606-10-32-11 through 32-13 on constraining

estimates of variable consideration, including the factors in paragraph 606-10-32-12. The entity

determines that it has significant experience with this product and with the purchasing pattern of the

entity. Thus, the entity concludes that it is probable that a significant reversal in the cumulative amount

of revenue recognized (that is, $100 per unit) will not occur when the uncertainty is resolved (that is,

when the total amount of purchases is known). Consequently, the entity recognizes revenue of $7,500

(75 units × $100 per unit) for the quarter ended March 31, 20X8.

ASC 606-10-55-219

In May 20X8, the entity’s customer acquires another company and in the second quarter ended

June 30, 20X8, the entity sells an additional 500 units of Product A to the customer. In light of the new

fact, the entity estimates that the customer’s purchases will exceed the 1,000-unit threshold for the

calendar year; therefore, it will be required to retrospectively reduce the price per unit to $90.

ASC 606-10-55-220

Consequently, the entity recognizes revenue of $44,250 for the quarter ended June 30, 20X8. That

amount is calculated from $45,000 for the sale of 500 units (500 units × $90 per unit) less the change

in transaction price of $750 (75 units × $10 price reduction) for the reduction of revenue relating to units

sold for the quarter ended March 31, 20X8 (see paragraphs 606-10-32-42 through 32-43).

It’s worth noting that, in Example 24 above, the entity continues to invoice the customer $100 per unit for

Product A and the customer continues to pay $100 per unit for Product A as the customer makes

purchases up to the 1,000 unit-threshold. The entity also recognizes a corresponding refund credit for the

amount it expects to refund the customer once the 1,000 unit threshold is met (that is, $10 per unit).

Determine the transaction price 96

Prospective volume discounts

An entity must evaluate contracts that include prospective volume discounts to determine if the discount

provides the customer with a material right. To determine whether the discount constitutes a material right

(Section 4.4), an entity compares the discount offered to similar customers that receive a discount

independently of a prior contract with the entity.

If the entity determines that the discount offered to a customer for prospective purchases and the price

offered to other similar customers, independent of a prior contract, are comparable, this may indicate that

the price offered exists independently of the existing contract. In other words, the discount is not

incremental to the discount typically given to similar high-volume customers and is therefore not a

material right. In this case, the entity has made a marketing offer that it should account for only when the

customer exercises the option to purchase the additional goods or services.

If, however, the entity determines that the volume-based discount offered to the customer and the price

typically offered to other similar customers independent of a prior contract are not comparable, this may

indicate that a portion of the customer’s payment at the earlier higher price (higher tier) is really just a

prepayment for later purchases at a lower price (lower tier). In other words, the discount provides the

customer with a material right and the entity should account for the material right as a separate

performance obligation, allocating a portion of the transaction price to the material right, which results in

the deferral of a portion of the earlier payment received. The entity recognizes the deferred revenue when

the future goods and services underlying the option are transferred to the customer.

The TRG discussed how an entity might determine if a prospective volume discount provides a material

right to the customer.

TRG area of general agreement: How should an entity determine if a prospective

volume discount provides a material right?

At the April 2016 meeting,

TRG members generally agreed with the framework outlined in a FASB

staff paper analyzing whether a material right exists when the contract price decreases per unit

prospectively based upon the volume of purchases. This framework suggested that customer options

that would exist independently of an existing contract with a customer do not constitute performance

obligations. That is, these options are not material rights.

The analysis was demonstrated through various examples, including the following arrangement with

prospective tiered pricing:

A manufacturer produces component parts that have various uses to multiple customers. The

parts are interchangeable and not customized for any particular customer. The entity enters

into a long-term Master Supply Agreement with Customer 1 whereby the pricing of parts in

subsequent years of the contract depends on the volume in the current year. For example, the

entity charges Customer 1 $1.00 per part in Year 1, and if Customer 1’s purchases exceed

100,000 parts in Year 1, the price per part decreases to $0.90 in Year 2. The tiered pricing

(volume discount) offered to Customer 1 is similar to the terms offered to many of the entity’s

customers.

TRG Paper 54, Considering Class of Customer when Evaluating Whether a Customer Option Gives

Rise to a Material Right.

Determine the transaction price 97

When evaluating whether the contract between the entity and Customer 1 includes a material right, the

entity first evaluates whether the option to receive a $0.10 discount per part in Year 2 exists

independently of the contract to purchase parts in Year 1.

To make this determination, the entity compares the discount offered to Customer 1 with the discount

typically offered to similar high-volume customers that receive a discount independent of a prior

contract with the entity.

The entity considers that Customer 2, another high-volume customer, has placed a single order with

the entity for 105,000 parts. Customer 2 has purchased parts from the entity in the past but none of its

prior contracts with the entity created an expectation to purchase parts in the future at a specified price

(and did not create an expectation for the entity to sell parts in the future at a specified price).