11.11 Amortization Period of Material Rights
In certain service contracts (e.g., month-to-month contracts), customers are required
to pay a one-time “activation fee” upon initially signing up for the service. Often,
the activities associated with the activation fee do not transfer a promised good or
service to the customer. In these situations, the activation fee is attributed to
the future services to be provided under the contract with the customer, as required
under ASC 606-10-55-51, and generally would give rise to a material right if the
customer can renew the service each month without incurring an additional activation
fee (i.e., the renewal is offered at a significant discount). ASC 606-10-55-42 and
ASC 606-10-55-51 provide the following limited guidance on how and over what period
such a material right should be recognized:
55-42 . . . 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.
55-51 . . . 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.
Often in these circumstances, the option to renew services without incurring an
additional activation fee is indefinite (i.e., the right to renew without paying an
activation fee may exist for the entire customer relationship).
Activation fees that give rise to a material right should not
necessarily be recognized over the entire customer life since the material right is
not always related to all goods or services that will be provided to the customer
under all anticipated contracts. Rather, an entity should determine the period over
which the right to renew a contract without incurring an additional activation fee
provides a material right to the customer. When making this assessment, an entity
should consider both qualitative and quantitative factors. Examples of these factors
include historical and projected customer behavior and the significance of the
activation fee in relation to the monthly contract price. In addition to evaluating
qualitative factors, one way to make the assessment is to compare the renewal rate
with the average monthly rate paid by the customer for the prior months’ services.
Under this approach, the discount provided upon renewal diminishes with each
successive renewal as the activation fee is attributed to additional months of
service, as illustrated in the example below.
Example 11-10
Entity A charges customers a monthly fee to obtain a bundle
of services on a month-to-month basis (i.e., the contract
period is one month, but customers have the right to renew
the services at a consistent monthly rate). In addition, all
new customers are required to pay a one-time activation fee
to initiate the service, but this fee is not required upon
renewal. No promised goods or services are transferred to
customers in connection with activation activities. Entity A
determines that the ability to renew a month of services
without having to pay an additional activation fee creates a
material right.
Assume the following additional facts:
- Each new customer pays a $30 activation fee that represents the stand-alone selling price of the material right.
- The customer can renew the monthly services for $140 per month indefinitely.
- Entity A has determined that its average customer life is seven years.
Although the customer can renew the monthly services
indefinitely without incurring an additional activation fee,
the period over which the right to do so represents a
material right to the customer is likely to be less than
seven years. While the option that exists in month 1 to
renew services for month 2 provides the customer with a
discount of approximately 17.6 percent as compared with the
first month of services, the option to renew in month 8
provides only a 2.6 percent discount as compared with the
average monthly amount paid to date. This is illustrated in
the following table:
In these circumstances, it is likely that the right to renew
the contract without incurring an additional activation fee
would not be material to the customer after a relatively
short period. As a result, recognizing the activation fee
over the entire customer life might not be required.
Accordingly, A will need to use judgment to determine when
the right to renew the contract without incurring an
additional activation fee no longer provides a material
right to the customer.