3.6 Gain Realization Contingent on Future Performance Requirements
An entity’s realization of a gain may be contingent on whether the
entity meets a future performance requirement. Alternatively, realization of a gain
may be contingent on future events outside the entity’s control. In both cases,
uncertainty remains and recognition of the gain contingency is not appropriate.
Other Codification topics prescribe different accounting treatment
when uncertainty or contingent events are outside or within the entity’s control. As
long as the uncertainty is within the scope of the gain contingency guidance in ASC
450-30, the entity should not analogize to other areas of guidance in U.S. GAAP when
evaluating the appropriateness of recognizing a gain contingency.
Example 3-6
Probable Occurrence of a
Contingent Future Event
Company J contracts to outsource its data
processing function to Company K for a period of seven
years. Approximately four years into the agreement term, K
seeks to terminate the agreement. Companies J and K sign a
termination agreement with the following terms:
- The agreement will fully terminate and K will cease processing transactions six months after the agreement is signed.
- Company J is required to find alternative outsourcing services before the end of the six-month term.
- Company K must pay J $5 million for signing the termination agreement. The payment from K to J is made when the agreement is signed but is subject to clawback if J fails to find alternative outsourcing services.
- If J fails to obtain the alternative outsourcing, K is required to provide such a service but may charge 150 percent of the standard monthly fee for doing so.
Company J believes that it is probable that
the conversion to a new provider will be accomplished within
the required time frame. Accordingly, J would like to
recognize the $5 million termination fee in income. However,
the recognition of the termination fee in income is
contingent on J’s ability to obtain alternative outsourcing
by the specified date. Therefore, the recognition of the
termination fee should be deferred until J has resolved all
uncertainties related to the termination agreement. This
will be achieved through successful negotiation of another
outsourcing agreement for J’s data processing function.
Example 3-7
Contingent Future Event
for Which No Additional Performance Is Required
Assume the same facts as in the example
above except that, in accordance with the termination
agreement, Company J can, and intends to, process its
transactions in-house after Company K ceases transaction
processing. That is, K has agreed to pay J $5 million to
terminate the agreement. There are no clawbacks. Since the
$5 million is realizable as of the date the termination
agreement is signed and becomes legally binding, J may
recognize the $5 million in earnings.