11.10 Recognition of Revenue Related to Options That Do Not Expire
In accordance with ASC 606-10-55-41 through 55-45, when an entity provides a customer
with an option to acquire additional goods or services that results in a performance
obligation because the option provides a material right to the customer, the entity
should (1) allocate a portion of the transaction price to the material right and (2)
recognize the related revenue either when the entity transfers control of the future
goods or services or when the option expires.
When a customer’s option to acquire additional goods is a material right and does not
expire, recognition of revenue related to the option will depend on whether the
material right is (1) included in a portfolio of similar rights provided by the
entity or (2) accounted for as an individual right. If the material right is
included in a portfolio of similar rights, revenue related to expected unexercised
options should be recognized in proportion to the pattern of rights exercised by the
customers in the portfolio. If the customer option is an individual right, the
entity would recognize revenue attributed to the material right when the likelihood
that the customer will exercise the option is remote.
The guidance on options requires an entity to estimate the stand-alone selling price
of the option at contract inception by considering the likelihood that the option
will be exercised. An entity should also consider the guidance in ASC 606-10-32-11
through 32-13 on constraining estimates of variable consideration to determine
whether it expects to be entitled to revenue related to unexercised options.
An entity would estimate the amount of revenue related to options that the entity
expects the customer will not exercise by applying the guidance on unexercised
rights in ASC 606-10-55-46 through 55-49. If there are any changes in the likelihood
of exercising the option, the entity should recognize such changes as it measures
progress toward satisfaction of the performance obligation. Accordingly, the entity
should recognize revenue as follows:
- Recognize revenue for the portion of the transaction price allocated to the option when the option is exercised.
- If the option has not been exercised, recognize revenue either (1) in proportion to the pattern of rights exercised by customers (for material rights included in a portfolio of similar rights) or (2) at the point in time when the entity determines that the likelihood that the customer will exercise the option becomes remote (when accounting for a single material right).
Example 52 in the revenue standard (ASC 606-10-55-353 through
55-356) demonstrates the allocation and recognition of changes in the expected
redemption of loyalty program points (i.e., options). See Section 11.2.2 for further discussion.
Example 11-8
Loyalty Points
An entity has a loyalty rewards program that offers customers
1 loyalty point per dollar spent; points awarded to the
customers do not expire. The redemption rate is 10 points
for $1 off future purchases of the entity’s products.
During a reporting period, customers
purchase products for $100,000 (which reflects the
stand-alone selling price of the products) and earn 100,000
points that are redeemable for future purchases. The entity
initially expects 95,000 points to be redeemed.
The entity estimates the stand-alone selling price to be
$0.095 per point (totaling $9,500) on the basis of the
likelihood of redemption in accordance with ASC
606-10-55-44. The points provide a material right to the
customers that they would not receive without entering into
a contract. Therefore, the entity concludes that the promise
to provide points to the customers is a performance
obligation.
The entity therefore allocates, at contract
inception, the transaction price of $100,000 as follows:
- Products — $100,000 × ($100,000 stand-alone selling price ÷ $109,500) = $91,324.
- Loyalty points — $100,000 × ($9,500 stand-alone selling price ÷ $109,500) = $8,676.
End of Year 1
After one year, 20,000 points have been
redeemed, and the entity continues to expect a total of
95,00011 points to be redeemed. Therefore, the entity
recognizes $1,827 in revenue for the 20,000 points redeemed,
or (20,000 points redeemed ÷ 95,000 total points expected to
be redeemed) × $8,676. The entity also recognizes a contract
liability of $6,849 ($8,676 − $1,827) for the unredeemed
points at the end of year 1.
End of Year 2
After two years, only 50,000 points in total
have been redeemed. The entity then reassesses the total
number of points that it expects the customers to redeem.
Its new expectation is that 70,000 (i.e., no longer 95,000)
points will be redeemed. Therefore, the entity recognizes
$4,370 in revenue in year 2. To calculate this amount, the
entity determines what portion of the $8,676 is to be
recognized in year 2, adjusting the total expected points to
be redeemed from 95,000 to 70,000:
$4,370 = [(50,000 total points redeemed ÷ 70,000
total points expected to be redeemed) × $8,676] –
$1,827 recognized in year 1.
The contract liability balance is $2,479
($6,849 − $4,370). The impact of the change in estimated
points that will be redeemed is recorded as a cumulative
adjustment in year 2. Alternatively, we believe that it may
be acceptable to recognize changes in estimate
prospectively.
End of Year 3
After three years, 55,000 points in total have been redeemed,
and the entity continues to expect that the customers will
redeem 70,000 points in total. Therefore, the entity
recognizes $620 in revenue in year 3. To calculate this
amount, the entity determines what portion of the $8,676 is
to be recognized in year 3 while maintaining the assumption
that the total expected points to be redeemed is 70,000:
$620 = [(55,000 total points redeemed ÷ 70,000
total points expected to be redeemed) × $8,676] –
$1,827 (recognized in year 1) – $4,370 (recognized
in year 2).
The contract liability balance is $1,859 ($2,479 – $620).
End of Year 4
After four years, no additional points have been redeemed,
and the entity concludes that the likelihood that customers
will redeem the remaining points is remote. The total
revenue recognized with respect to the material right in
year 4 would be the remaining contract liability balance of
$1,859.
Example 11-9
Single Customer Option
An entity enters into a contract with a customer for the sale
of Product A for $100. As part of the negotiated
transaction, the customer also receives a coupon for 50
percent off the sale of Product B; the coupon does not
expire. Similar coupons have not been offered to other
customers.
The stand-alone selling price of Product B is $60. The entity
estimates a 70 percent likelihood that the customer will
redeem the coupon. On the basis of the likelihood of
redemption, the stand-alone selling price of the coupon is
concluded to be $21 ($60 sales price of Product B × 50%
discount × 70% likelihood of redemption) in accordance with
ASC 606-10-55-44.
The entity concludes that the option to purchase Product B at
a discount of 50 percent provides the customer with a
material right. Therefore, the entity concludes that (1)
this option is a performance obligation and (2) a portion of
the transaction price for Product A should be allocated to
this option.
The entity therefore allocates, at contract
inception, the $100 transaction price as follows:
- Product A — $100 × ($100 stand-alone selling price ÷ $121) = $83.
- Product B material right — $100 × ($21 stand-alone selling price ÷ $121) = $17.
The option is not exercised during the first four years after
its issuance. As a result, the entity determines that no
revenue should be recognized during this period by applying
the guidance in ASC 606-10-55-48, which allows revenue to be
recognized “in proportion to the pattern of rights exercised
by the customer.” At the end of year 4, the entity
determines that the likelihood that the customer will redeem
the coupon has become remote and therefore recognizes the
$17 in accordance with ASC 606-10-55-48.
Footnotes
11
The estimate of points to be redeemed that an entity
makes at the end of year 1 and subsequent years may
not always be the same as the initial estimate of
points to be redeemed that the entity made to
determine the stand-alone selling price of the
performance obligation related to the points
issuance (i.e., the material right). This is because
when determining the amount of revenue to recognize
as points are redeemed, an entity would need to
update its estimate of the total points that it
expects to be redeemed (i.e., the entity would need
to assess whether actual breakage is expected to be
more or less than the initial estimate used to
establish the stand alone selling price of the
performance obligation related to the points
issuance). An entity would not change amounts
allocated to the material right obligation for
subsequent changes in the estimate of loyalty points
to be redeemed, but such changes in estimate would
affect the amount of revenue recognized for points
redeemed during the reporting period and could
inform the stand-alone selling price for loyalty
points issued as part of new contracts with
customers.