Appendix C — Summary of Issues Addressed in the FASB Staff’s Revenue Recognition Implementation Q&As and/or by the TRG

C.12 Contract Costs (Chapter 13 of the Roadmap)

C.12.1 Capitalization and Amortization of Incremental Costs of Obtaining a Contract — TRG Agenda Papers 23, 25, 57, and 60

Because many entities pay sales commissions to obtain contracts with customers, questions have arisen regarding how to apply the revenue standard’s cost guidance to such commissions, including:

Whether certain commissions (e.g., commissions on contract renewals or modifications, commission payments that are contingent on future events, and commission payments that are subject to “clawback” or thresholds) qualify as contract assets.
The types of costs to capitalize (e.g., whether and, if so, how an entity should consider fringe benefits such as payroll taxes, pension, or 401(k) match) in determining the amount of commissions to record as incremental costs.

The accounting for sales commissions is generally straightforward when (1) the commission is a fixed amount or a percentage of contract value and (2) the contract is not expected to be (or cannot be) renewed. However, if compensation plans are complex, it may be difficult to determine which costs are truly incremental and to estimate the period of amortization related to them. Examples of complex scenarios include:

Plans with significant fringe benefits.
Salaries based on the employee’s prior-year signed contracts.
Commissions paid in different periods or to multiple employees for the sale of the same contract.
Commissions based on the number of contracts the salesperson has obtained during a specific period.
Legal and travel costs incurred in the process of obtaining a contract as well as anticipated contract renewals.

In these instances, stakeholders have questioned:

Whether certain costs incurred to obtain a contract are incremental.
How an entity should determine the amortization period for an asset recognized for the incremental costs of obtaining a contract with a customer, and more specifically:
- How an entity should determine whether a sales commission is related to goods or services to be transferred under a specific anticipated contract.
- If a sales commission is paid for an initial contract and also paid for contract renewals, how an entity should evaluate whether the sales commission paid on the contract renewal is commensurate with the sales commission paid on the initial contract.

C.12.1.1 Commission Payments Subject to Clawback — Implementation Q&As 67 and 68 (Compiled From TRG Agenda Papers 23 and 25)

Stakeholders have questioned whether commission payments that are contingent on future customer performance under the contract should be capitalized as incremental costs of obtaining a contract. If a contract has qualified for recognition under step 1 (ASC 606-10-25-1), the entity has concluded that the “parties to the contract . . . are committed to perform their respective obligations.”33 Therefore, the entire commission payment (or obligation, if the commission is not paid) should be capitalized at contract inception. If circumstances change over time, the entity should reassess whether there is a valid revenue contract and assess the contract cost asset for impairment.

C.12.1.2 Commissions Paid on Contract Modifications — Implementation Q&A 73 (Compiled From TRG Agenda Papers 23 and 25)

When a commission is paid on a contract modification that is not accounted for as a separate contract, the commission should still be capitalized if it is an incremental cost of obtaining a contract.

C.12.1.3 Capitalization of Fringe Benefits — Implementation Q&A 74 (Compiled From TRG Agenda Papers 23, 25, 57, and 60)

When fringe benefits are incurred as a direct result of incurring the commission (such as payroll taxes or pension costs based on the incremental commission amount paid), the fringe benefits should be capitalized because they are costs “that [the entity] would not have incurred if the contract had not been obtained.”34

C.12.1.4 Commissions Based on Achievement of Cumulative Targets — Implementation Q&A 69 (Compiled From TRG Agenda Papers 23 and 25)

Stakeholders have raised questions regarding the application of the revenue standard’s cost guidance to commission plans that contain cumulative targets. For example, a salesperson may earn (1) a 5 percent commission on all contracts signed in the period if 1 through 5 contracts are signed and (2) a 10 percent commission on all contracts signed in the period if 6 through 10 contracts are signed. Implementation Q&A 69 contains examples illustrating variations of commission plans with similar cumulative targets and discusses two acceptable views on how to account for the commissions. Under those views, the commissions in the fact pattern described above may be accounted for as follows:

View 1 — The commission paid as a result of signing contract 6 includes the incremental 5 percent commission on contracts 1 through 5. The entity should capitalize this incremental cost upon signing contract 6. If the entity applies this view, the entity may determine that the commission it paid upon signing contract 6 should be allocated to contracts 1 through 6 for purposes of determining the period of amortization.
View 2 — The entity should estimate the amount of commission that will ultimately be paid for each contract and recognize that amount upon signing each contract. If the entity estimated that it would sign 7 contracts during the period, a commission of 10 percent of the value of contract 1 would be accrued upon signing.

C.12.1.5 Determining Which Costs Incurred to Obtain a Contract Are Incremental — Implementation Q&A 78 (Compiled From TRG Agenda Papers 57 and 60)

An entity should consider whether costs would have been incurred if the customer (or the entity) decided that it would not enter into the contract just as the parties were about to sign the contract. If the costs (e.g., legal costs to draft the contract) would have been incurred even though the contract was not executed, they would not be incremental costs of obtaining a contract.

The TRG cautioned that entities would need to use judgment to determine whether certain costs, such as commissions paid to multiple employees for the signing of a contract, are truly incremental. The FASB staff encouraged entities to apply additional skepticism to understand whether an employee’s compensation (i.e., commissions or bonus) — particularly for individuals in different positions in the organization and employees who are ranked higher in an organization — is related solely to executed contracts or is also influenced by other factors or metrics (e.g., employee general performance or customer satisfaction ratings). TRG members emphasized that only those costs that are incremental (i.e., the result of obtaining the contract) may be capitalized (if other asset recognition criteria are met).

Implementation Q&A 78 includes the following illustrative fact patterns and conclusions:

Employee salary — An entity pays an employee an annual salary that is based on contracts signed in the prior year. The salary amount will not change on the basis of contracts signed in the current year, but salary in the subsequent year will be based on current-year contracts signed. No portion of the current-year salary should be capitalized as an incremental cost of obtaining a contract because the costs would be incurred regardless of the contracts signed in the current year.
Identifying incremental costs — An entity pays an employee a 5 percent sales commission when a new contract with a customer is signed. In negotiating the contract, the entity incurs legal and travel costs. The entity should capitalize the sales commission because it is an incremental cost that the entity would not have incurred if the contract had not been signed. Because the legal and travel costs would still have been incurred if the contract had not ultimately been signed, they are not considered incremental costs of obtaining a contract and therefore should not be capitalized.
Timing of payment — An employee earns a 4 percent sales commission when a new contract with a customer is signed. The entity pays half of the commission to the employee immediately upon signing, and the remaining half is paid to the employee six months later even if the employee is no longer employed by the entity at the time. The full sales commission should be capitalized upon signing because the only requirement for the employee to receive the second payment is the passage of time. There may be other fact patterns with additional contingencies to consider, including customer satisfaction surveys, incremental sales, or continued employment, which may need to be assessed further.
Level of employee — When a contract with a customer is signed, an entity pays a 10 percent commission to the salesperson, a 5 percent commission to the manager, and a 3 percent commission to the regional manager. All of these commissions should be capitalized because they would not have been incurred if the contract had not been signed.
Payments subject to a threshold — An entity has a sales commission plan under which the amount a salesperson receives increases on the basis of the cumulative number of contracts obtained during a period. If 0 through 9 contracts are obtained during a period, the salesperson receives no commission. If 10 through 19 contracts are obtained during a period, the salesperson receives a 2 percent commission based on the total value of contracts signed in the period. The commission costs are incremental costs of obtaining a contract, and the entity should apply other GAAP to determine whether a liability should be recognized.

C.12.1.6 Determining the Amortization Period for the Incremental Costs of Obtaining a Contract — Implementation Q&A 79 (Compiled From TRG Agenda Papers 57 and 60)

The amortization period should reflect the period in which the entity expects to receive benefits from the underlying goods or services to which the asset is related. In estimating an amortization period, entities will need to apply judgment to determine the related goods and services and assess which contracts (i.e., initial contract and renewals) include those goods and services. An entity would need to make judgments similar to those it made when determining the amortization or depreciation period for other long-lived assets.

In Implementation Q&A 79, the FASB staff notes that although an entity’s particular facts and circumstances may support a determination that the best estimate of the amortization period is the average customer term, such term is not necessarily identical to the average period in which third parties have been customers (i.e., the average customer life). The staff observes that “[i]n most industries, the goods and services that an entity was providing two decades ago are very different from the goods and services the entity currently provides to its customers.” Since “it is unlikely that a commission paid twenty years ago has any relationship to the goods or services provided today,” it is doubtful that amortizing the commission over a period of 20 years would be consistent with the requirement in ASC 340-40-35-1 to amortize an asset “on a systematic basis that is consistent with the transfer to the customer of the goods or services to which the asset relates.”

C.12.1.7 Amortization of Commissions Paid on the Initial Contract and Renewals — Implementation Q&As 70, 71, and 72 (Compiled From TRG Agenda Papers 23, 25, 57, and 60)

When a commission plan provides an employee with a commission (that is an incremental cost) for an initial contract with a customer as well as for renewals, the costs incurred at inception (and upon renewals) should be capitalized on their respective initial (and renewal) contract inception dates because they are costs that would not have been incurred if the initial contract (and renewals) had not been obtained.

When the commission paid upon renewal is not commensurate with the commission paid for the initial contract with the customer and there are anticipated renewals, there are two acceptable alternatives for recording the amortization of the commission asset:

Amortize the initial capitalized cost over the original contract period and the period of anticipated renewals. Amortize the capitalized costs for renewals over their respective renewal periods.
Amortize (1) the portion of the initial capitalized cost that is equal to commissions paid upon renewal over the initial contract period and (2) the remainder over the initial contract period and anticipated renewals. Amortize the capitalized costs for renewals over their respective renewal periods.

Either of the above alternatives could be acceptable if applied consistently to similar circumstances. If there are no specifically anticipated future contracts, it would be appropriate to amortize the full contract cost at inception over the original contract term and any subsequent renewal costs over their respective terms.

To determine whether the commission paid for a contract renewal is commensurate with commissions paid for initial contracts, an entity should perform an analysis to determine whether the two commission amounts are reasonably proportional to the value of their respective contracts. The analysis should not be based on the level of effort required to obtain the initial and renewal contracts.

C.12.1.8 Determining Whether a Sales Commission Is Related to Goods or Services to Be Transferred Under a Specific Anticipated Contract — Implementation Q&A 80 (Compiled From TRG Agenda Papers 57 and 60)

The asset recognized for incremental costs of obtaining a contract may be related to goods or services under a specific anticipated contract and therefore may be amortized over the related period. If the entity expects that an initial contract will not be renewed on the basis of the relevant facts and circumstances, amortizing the asset over only the initial contract term would be an appropriate application of the revenue standard. Alternatively, if the entity expects that renewal of the initial contract is likely, the amortization period for the asset may be longer than the initial contract term. Entities will need to evaluate the relevant facts and circumstances, including historical experience, to make a reasonable judgment.

C.12.1.9 Determining the Pattern of Amortization for a Contract Cost Asset Related to Multiple Performance Obligations — Implementation Q&A 75 (Compiled From TRG Agenda Papers 23 and 25)

ASC 340-40-35-1 states that capitalized costs should be amortized “on a systematic basis that is consistent with the transfer to the customer of the goods or services to which the asset relates.” Stakeholders have questioned the appropriate pattern of amortization when the contract asset is related to multiple performance obligations that are satisfied over disparate points or periods. There are two views that, depending on the relevant facts and circumstances, may satisfy the requirement in the guidance:

View A — The contract cost asset should be allocated in proportion to the amount of the transaction price allocated to each performance obligation and amortized on the basis of the pattern of revenue recognition for each performance obligation.
View B — The contract cost asset should be amortized by using one measure of performance that best reflects the use of the asset and takes into account all performance obligations in the contract. View B would not require allocation on a relative stand-alone selling price basis, but the accounting outcomes under View A and View B should be reasonably similar.

Either approach can be applied to contract cost assets that also include specifically anticipated future contracts. In such instances, the pattern of amortization should reflect the expected pattern of revenue recognition for the initial and expected future contracts.

C.12.2 Impairment Testing of Capitalized Contract Costs — TRG Agenda Papers 4 and 5

To test contract assets for impairment, an entity must consider the total period over which it expects to receive an economic benefit from the contract asset. Accordingly, to estimate the amount of remaining consideration that it expects to receive, the entity would also need to consider goods or services under a specific anticipated contract (i.e., including renewals). However, the impairment guidance as originally issued appeared to contradict itself because it also indicated that entities should apply the principles used to determine the transaction price when calculating the “amount of consideration that an entity expects to receive.”35 The determination of the transaction price would exclude renewals.36

TRG members generally agreed that when testing a contract asset for impairment, an entity would consider the economic benefits from anticipated contract extensions or renewals if the asset is related to the goods and services that would be transferred during those extension or renewal periods.

In December 2016, as noted in Section C.2.2, the FASB issued ASU 2016-20 on technical corrections to the revenue standard, which amends ASC 340-40 to clarify that for impairment testing, an entity should:

Consider contract renewals and extensions when measuring the remaining amount of consideration the entity expects to receive.
Include in the amount of consideration the entity expects to receive both (1) the amount of cash expected to be received and (2) the amount of cash already received but not yet recognized as revenue.
Test for and recognize impairment in the following order: (1) assets outside the scope of ASC 340-40 (such as inventory under ASC 330), (2) assets accounted for under ASC 340-40, and (3) reporting units and asset groups under ASC 350 and ASC 360.

Refer to Chapter 13 for additional information.

C.12.3 Preproduction Activities

The revenue standard contains guidance on fulfillment costs that are outside the scope of other Codification topics, including costs related to an entity’s preproduction activities. The Background Information and Basis for Conclusions of ASU 2014-09 indicates that in developing such cost guidance, the FASB and IASB did not intend to holistically reconsider cost accounting. Rather, they aimed to:

Fill gaps resulting from the absence of superseded guidance on revenue (and certain contract costs).
Improve consistency in the application of certain cost guidance.
Promote convergence between U.S. GAAP and IFRS Accounting Standards.

Summarized below are issues related to how an entity should apply the new cost guidance when assessing preproduction activities, including questions related to the scope of the guidance (i.e., the costs to which such guidance would apply).

C.12.3.1 Whether Entities Should Continue to Account for Certain Preproduction Costs Under ASC 340-10, and Whether Preproduction Costs for Contracts Previously Within the Scope of ASC 605-35 Will Be Within the Scope of ASC 340-10 or ASC 340-40 — Implementation Q&A 66 (Compiled From TRG Agenda Papers 46 and 49)

Since the revenue standard did not amend the guidance in ASC 340-10, entities that have historically accounted for preproduction costs in accordance with ASC 340-10 should continue to do so. See Chapter 3 for further developments on this matter.

Preproduction activities related to contracts historically within the scope of ASC 605-35 should be accounted for in accordance with ASC 340-40 because (1) the revenue standard supersedes ASC 605-35 (and its related cost guidance) and (2) ASC 340-10 does not provide guidance on costs related to such contracts. However, entities should continue to account for preproduction costs related to long-term supply arrangements that are within the scope of ASC 340-10 in accordance with ASC 340-10. For additional information, see Chapters 3 and 13.

C.12.3.2 Accounting for Customer Reimbursement of Preproduction Costs — Implementation Q&A 65 (Compiled From TRG Agenda Papers 46 and 49)

Under legacy U.S. GAAP, some entities presented customer reimbursements for preproduction or nonrecurring engineering (NRE) costs as revenue and others as contra-expense. Under the revenue standard, an entity will first determine whether the contract is within the scope of ASC 606. The entity will then determine whether the preproduction (or NRE) activities are a performance obligation. Depending on that determination, the reimbursement for the costs is accounted for as follows:

If the preproduction activities are a set-up or administrative task that does not transfer a good or service, the reimbursement is included in the transaction price and recognized as control of the related production units is transferred.
If the preproduction activities are a distinct performance obligation, the reimbursement is recognized as revenue when or as control is transferred.
If the preproduction activities are part of a combined performance obligation, the reimbursement is included in the transaction price and recognized by using a single measure of progress for the combined single performance obligation.

C.12.4 Accounting for Reimbursements From Customers for Out-of-Pocket Expenses — Implementation Q&A 64

Because the revenue standard does not contain any guidance that explicitly addresses the accounting for reimbursement from customers of out-of-pocket expenses, the FASB staff decided to address key considerations related to that issue in Implementation Q&A 64. Specifically, stakeholders have questioned when an entity would be required to estimate reimbursements for out-of-pocket expenses from customers as a form of variable consideration. Implementation Q&A 64 includes analysis of the guidance on variable consideration and notes that variable consideration would not need to be estimated in the following circumstances:

The entity is an agent with respect to the performance obligation.
The variable consideration is fully constrained on the basis of an analysis of the entity’s facts and circumstances.
The variable consideration is related to a performance obligation or to distinct good or service in a series, and allocating the consideration to the specific good or service would meet the allocation objective.
The entity recognizes the related revenue over time and applies either (1) the “as invoiced” practical expedient or (2) an input cost-to-cost method.

Although materiality is not specifically contemplated in the accounting guidance, Implementation Q&A 64 also notes that in the FASB staff’s view, an entity may be able to conclude in many circumstances that the impact of out-of-pocket reimbursements is immaterial.

Footnotes

Quoted from ASC 606-10-25-1(a).

Quoted from ASC 340-40-25-2.

Quoted from ASC 340-40-35-4 as originally worded.

ASC 606-10-32-4 states, “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.”

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.