Chapter 11 — Customer Options for Additional Goods or Services (Material Rights)
Chapter 11 — Customer Options for Additional Goods or Services (Material Rights)
11.1 In General
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.
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.
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.
An entity’s contract with a customer may give the customer a choice
of whether to purchase additional goods or services; such a choice is typically
referred to as an option for additional goods or services. Options for additional
goods or services may include, but are not limited to:
- Loyalty programs in which customers accumulate points that may be used to acquire future goods or services.
- Discount vouchers.
- Renewal options.
- Contracts that include (1) a customer’s payment of a nonrefundable up-front fee and (2) renewal options.
In some cases, such options are marketing or promotional efforts to
gain future contracts with customers. However, in other cases, such options are
purchased (often implicitly) in conjunction with a present customer contract.
Entities are required to identify options for additional goods or
services because in certain circumstances, such options can lead to performance
obligations. As explained in paragraph BC386 of ASU
2014-09, the FASB and IASB realized that it could be difficult
to differentiate between (1) an option for additional goods or services that was
paid for by the customer and (2) a marketing or promotional offer for which the
customer did not pay. The first type of option for additional goods or services
would be identified as a performance obligation to which consideration must be
allocated in accordance with step 4 (see Chapter 7) of the revenue standard.
To help entities determine whether an option for additional goods or
services is a performance obligation, the boards included the concept of a material
right in the revenue standard. If an entity determines that an option for additional
goods and services is a material right, the option should be considered a
performance obligation. However, an entity will need to use judgment to determine
whether a material right exists.
A material right in a contract is provided to a customer only if the
customer would not have received it without entering into that contract. The
guidance in the revenue standard describes an example of a material right as an
option that provides the customer an incremental discount beyond the discounts that
are typically given (considering the class of customer).
11.2 Determining Whether an Option for Additional Goods or Services Represents a Material Right
The example below, which is reproduced from ASC 606, illustrates a
contract with an option for additional goods or services that is akin to a marketing
offer and thus does not represent a material right.
ASC 606-10
Example 50 — Option That Does Not Provide
the Customer With a Material Right (Additional Goods or
Services)
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.
55-341 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).
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.
Once a material right is identified, it must be accounted for as a
performance obligation. However, the identification of material rights has been the
focus of many questions from stakeholders.
In determining whether an option for future goods or services is a
material right, an entity should (1) consider factors outside the current
transaction (e.g., the current class of customer1) and (2) assess both quantitative and qualitative factors. Further, an entity
should also evaluate incentives and programs to understand whether they are customer
options designed to influence customer behavior (i.e., an entity should consider
incentives and programs from the customer’s perspective) because this could be an
indicator that an option is a material right.
For example, regarding certain offers, such as “Buy three, get one
free,” the quantities involved are less important than the fact that an entity would
be “giving away” future sales in such cases. While not determinative, such an
indicator may lead an entity to conclude that a customer option is a material
right.
When determining whether a contract option provides a material
right, entities should consider not only the quantitative significance of the option
(i.e., the quantitative value of the benefit) but also previous and future
transactions with the customer as well as qualitative factors. Specifically,
qualitative features such as whether the rights accumulate (e.g., loyalty points)
are likely to provide a qualitative benefit that may give rise to a material right.
In accordance with ASC 606-10-25-16B, entities should not apply the guidance in ASC
606-10-25-16A on assessing whether promises for immaterial goods or services are
performance obligations to the assessment of whether a contract option provides a
material right (i.e., an optional good offered for free or at a discount, such as
that provided through loyalty point programs, may not be material for an individual
contract but could be material in the aggregate and accounted for as a material
right).
An entity should consider its customer’s reasonable expectations
when identifying promised goods or services. A customer’s perspective on what
constitutes a material right might consider qualitative factors (e.g., whether the
right accumulates). Therefore, a numeric threshold alone might not determine whether
a material right is provided by a customer option in a contract.
Refer to Examples 49 (Section 11.8), 50 (Section 11.2), 51 (Section 11.9), and 52 (Section 11.2.2) in ASC 606-10-55-336 through
55-356 for illustrations of how an entity would determine whether an option provides
a customer with a material right. In addition, some industries, such as the software
industry, more commonly provide customers with options to purchase additional goods
or services. Refer to Sections
12.3.3.1 and 12.6.3.2 for examples of how an entity would assess whether options
to purchase additional copies of software or options to renew postcontract customer
support (PCS) provide a customer with a material right.
The above issue is addressed in Q&As 12 through 14 (compiled
from previously issued TRG Agenda Papers 6, 11, 54, and 55) of the FASB staff’s Revenue Recognition Implementation
Q&As (the “Implementation Q&As”). For additional
information and Deloitte’s summary of issues discussed in the Implementation
Q&As, see Appendix
C.
11.2.1 Need for Assessing Whether a Material Right Exists When the Residual Approach Was Used to Establish the Stand-Alone Selling Price of the Additional Goods or Services
Determining the stand-alone selling price of goods or services
offered to a customer under a contract option is a necessary step in the
assessment of whether a material right exists. The ability to sell certain goods
or services for a wide range of prices may make it difficult to establish the
stand-alone selling price of goods or services offered to a customer under a
contract option (e.g., a renewal option). This is especially true in the
software industry, in which the incremental costs incurred to sell additional
software licenses are often minimal and therefore allow software entities to
sell their software at prices spanning a wide range of discounts or even
premiums. Consequently, the FASB included the residual approach in ASC 606 as a
“suitable” method for establishing the stand-alone selling price.
If an entity applied the residual approach to establish the
stand-alone selling price of goods or services because the stand-alone selling
price of those goods or services is highly variable or uncertain, the entity is
required to assess whether an option (e.g., a renewal option) to acquire more of
those goods or services conveys a material right to the customer. Under ASC
606-10-55-41 through 55-45, a customer option to purchase additional goods or
services gives rise to a material right if the option provides the entity’s
customer with a discount that is incremental to the range of discounts typically
given for those goods or services to that class of customer (e.g., a customer in
a particular geographic area or market). It would not be appropriate for the
entity to conclude that no material right was conveyed to the customer simply
because the stand-alone selling price of the goods or services that are subject
to the option is highly variable or uncertain and the residual approach was
therefore applied.
When the residual approach is used to determine the stand-alone
selling price of a good or service because pricing is highly variable or
uncertain, assessing whether option pricing for that good or service provides a
material right may require significant judgment because of the lack of a point
estimate or sufficiently consistent range representing the stand-alone selling
price. While we believe that entities are likely to identify fewer material
rights in such cases, they are nonetheless required to base their determination
of whether a material right was provided on all reasonably available
information. Although the presence of highly variable or uncertain pricing
complicates the identification of material rights, we believe that when doing
so, an entity should consider (1) the definition of a material right2 and (2) the allocation objective in ASC 606-10-32-28. In other words, an
entity must determine whether the pricing of the optional good or service (1)
indicates that preferential pricing would not have been received “but for” the
initial contract or (2) reflects the amount to which the entity expects to be
entitled in exchange for transferring that good or service to the customer. If
the pricing does not meet the allocation objective (i.e., it is a discount that
is incremental to what other similar customers would receive), a material right
should be identified. We believe that an entity might find the following factors
useful in determining whether a material right is present when the pricing of
optional future purchases is highly variable or uncertain:
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How the pricing of the optional future purchase aligns with current pricing policies and practices — For example, if a good or service is not typically sold below a certain amount because it is a premium offering, an option to buy the good or service at an amount below that floor would be at odds with standard pricing practices and may therefore convey a material right to the customer.
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How the pricing of the optional future purchase compares to historical amounts allocated to the good or service in similar situations — Such a comparison is likely to require an entity to look to historical data and stand-alone selling prices that were derived by using the residual approach. Accordingly, while there will not be an established point estimate or narrow range of stand-alone selling prices against which to compare the pricing of the optional future purchase, ASC 606-10-32-34(c) indicates that the residual approach is a method of establishing a stand-alone selling price. Therefore, the amounts determined under that approach represent the stand-alone selling price for that good or service. Consequently, we believe that in assessing whether a customer has been given a material right, an entity may obtain useful information by comparing the pricing of an optional future purchase with historical stand-alone selling prices that were determined as a result of applying the residual approach. In addition, to determine which range of historical stand-alone selling prices to compare with the pricing of the optional future purchase, entities should consider only those transactions that are similar to the transaction in question. For example, an entity might disaggregate historical stand-alone selling price data by one or more of the following characteristics: class of customer, geography, distribution channel, or contract value.
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How the pricing of the optional future purchase compares to historical contractually stated pricing (if any) of the good or service in similar situations — While the contractually stated pricing may not necessarily represent the stand-alone selling price (see ASC 606-10-32-32), the historical price across a range of different contracts may nevertheless be relevant evidence of an entity’s pricing practices and discounts it may offer on future purchases.
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Whether the pricing of the optional future purchase is intended to incorporate a discount — If the intent during negotiations was to give the customer a discount on future purchases, a material right may exist since the allocation objective is less likely to be met in such cases. For example, a customer may only have agreed to enter into an initial contract if the vendor offered discounted pricing on future purchases.
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Whether the pricing of the optional future purchase is discounted relative to (1) the price of similar goods or services sold under the initial contract or (2) the list price when compared with the discounted list prices of all goods or services (whether similar or not) sold under the initial contract — We acknowledge that this factor conflicts with the FASB’s reasons for departing from its definition of a significant incremental discount in legacy GAAP under ASC 985-605. In paragraph BC387 of ASU 2014-09, the Board indicates its rationale for defining “incremental” solely by reference to other comparable transactions:[T]he Boards observed that even if the offered discount is not incremental to other discounts in the contract, it nonetheless could, in some cases, give rise to a material right to the customer. Consequently, the Boards decided not to carry forward that part of the previous revenue recognition guidance from U.S. GAAP into Topic 606.However, we believe that when evaluated in conjunction with all other available evidence, a comparison of the pricing of the optional future purchase with any discounts offered in the initial contract may provide insight into an entity’s pricing practices and discounting intentions. Pricing of the optional future purchase at an amount that is lower than the price under the original contract may indicate the presence of a material right. Conversely, pricing of the optional future purchase at an amount that is lower than the list price but is nevertheless consistent with the discounted price charged under the original contract may be evidence to support a conclusion that the discounted price represents the stand-alone selling price.
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How the pricing of the optional future purchase aligns with any intended future pricing for similar goods or services — For example, an option to buy add-on software at a set price may not give the customer a material right if that price approximates the amount at which management intends to sell that software on a stand-alone basis in the near future.
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The relative negotiating power of the entity and the customer — In certain situations, customers may have a greater ability to demand discounted pricing on optional future purchases if the customers represent significantly larger, well-known brands that are dominant in their markets, are more mature, or are otherwise better positioned than the entity selling the goods or services.
The above factors are not intended to be all-inclusive or prescriptive, and each
factor on its own may not be determinative. Entities may need to use significant
judgment when determining whether a material right has been granted. Entities
with highly variable or uncertain pricing should establish a policy for
evaluating material rights and apply that policy consistently in similar
situations.
The examples below demonstrate the application of some of the concepts described
above.
Example 11-1
Entity J, an early-stage software developer, enters into
an arrangement with Customer T, a large U.S.-based
company, to license its software on a term basis and
provide PCS for one year. The arrangement also includes
hardware and professional services. The total
transaction price is $2 million, and J has established
that the license, PCS, hardware, and professional
services each represent a distinct performance
obligation.
Entity J has concluded that the pricing of software
licenses is highly variable and uses the residual
approach to determine the stand-alone selling price. The
observable stand-alone selling prices of the other
performance obligations are as follows:
- PCS — $200,000.
- Professional services — $500,000.
- Hardware — $300,000.
Under the residual approach, $1 million is allocated to
the software license, which J determines is consistent
with the allocation objective. The contract also
indicates that the customer may renew the software
license for $250,000 per additional year and that the
pricing for other products and services will be at their
stand-alone selling prices.
Entity J reviews historical transaction data for sales of
software licenses to large customers in the United
States to determine the amounts that have been allocated
to the software license under the residual approach.
Over the past year, a range of $500,000 to $3 million
has been allocated to the software license, which is
consistent with J’s pricing policies. While J did not
initially intend to give T a discount, it was willing to
negotiate on renewal pricing because it wanted to secure
the large contract and is able to enhance the
marketability of its products by obtaining T as a
customer (T is a well-known brand and dominant in its
market). Therefore, J concludes that the pricing of the
optional future purchase has given T a material
right.
We believe that the following factors indicate that T has
received a material right:
- A comparison of (1) the price T must pay if it exercises its option to renew the license in the future ($250,000) and (2) the range of stand-alone selling prices determined under the residual approach in similar historical transactions ($500,000 to $3 million) indicates that the pricing offered to T does not meet the allocation objective because T is receiving a significant discount that is incremental to the range of discounts offered to other similar customers.
- Although J did not initially intend to give T a discount on future purchases, other facts and circumstances indicate that J nonetheless offered T preferential pricing.
Example 11-2
Entity A enters into an arrangement with
Customer C, a midsized company based in Europe, to
license its software on a term basis and provide PCS for
one year. The arrangement also includes hardware and
professional services. The total transaction price is
$20,000, and A has established that the license, PCS,
hardware, and professional services each represent a
distinct performance obligation.
Entity A has concluded that the pricing of software
licenses is highly variable and uses the residual
approach to determine the stand-alone selling price. It
has observable stand-alone selling prices for its other
products and services. The list price, contractually
stated price, discount from list price, and stand-alone
selling price of each performance obligation are as
follows:
The contract also indicates that the customer may renew
the software license for $3,000 per additional year,
which represents a 60 percent discount from the list
price, and that the pricing for other products and
services remains at the same contractually stated
prices.
Entity A reviews historical transaction
data for sales of software licenses to midsized
customers in Europe to determine the contractually
stated prices and related discounts from list price for
the software license. Over the past year, the software
license has been priced between $1,000 to $20,000, thus
ranging from a discount of 87 percent to a premium of
167 percent relative to the list price. Entity A’s
internal pricing policies require that discounts of over
50 percent must undergo an extensive approval process.
Further, A intended to give C a discount on renewals of
the software license because A is in a highly
competitive market in which customer retention is
difficult. In addition, C indicated that it would
purchase large additional amounts of hardware.
Therefore, A concludes that the pricing of the optional
future purchase(s) gives C a material right.
We believe that the following factors indicate that C has
received a material right:
- It is not especially meaningful to compare (1) the discount to the list price C receives if it exercises its option to renew the license in the future (60 percent) with (2) the range of discounts and premiums in similar historical transactions (87 percent discount to 167 percent premium) given the significant pricing variation observed in the data. However, A’s internal pricing policies require any discounts of over 50 percent undergo an extensive approval process.
- On the basis of a comparison of (1) the discount from list price for the renewal pricing (60 percent) with (2) the other discounts offered in the same contract (0 percent to 38 percent for other goods and services and 40 percent for the same software license), A determines that the optional future purchase pricing conveys an incremental discount to C that it did not receive under the initial contract.
- Entity A’s intention to give C a discount to secure its future business in a competitive market supports a conclusion that “but for the initial contract,” C would not have received favorable pricing on future software license renewals.
- Customer C’s indication that it would make many additional purchases of hardware supports A’s decision to provide preferential pricing.
11.2.2 Loyalty Programs and Accumulation Features
ASC 606-10
Example 52 — Customer Loyalty
Program
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 (totalling $9,500) on the basis
of the likelihood of redemption in accordance with
paragraph 606-10-55-44.
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. The entity
allocates the transaction price ($100,000) to the
product and the points on a relative standalone selling
price basis as follows:
Product $91,324 [$100,000 × ($100,000
standalone selling price ÷ $109,500)]
Points $8,676 [$100,000 × ($9,500 standalone
selling price ÷ $109,500)]
55-355 At the end of the
first reporting period, 4,500 points have been redeemed,
and the entity continues to expect 9,500 points to be
redeemed in total. The entity recognizes revenue for the
loyalty points of $4,110 [(4,500 points ÷ 9,500 points)
× $8,676] and recognizes a contract liability of $4,566
($8,676 – $ 4,110) for the unredeemed points at the end
of the first reporting period.
55-356 At the end of the
second reporting period, 8,500 points have been redeemed
cumulatively. The entity updates its estimate of the
points that will be redeemed and now expects that 9,700
points will be redeemed. The entity recognizes revenue
for the loyalty points of $3,493 {[(8,500 total points
redeemed ÷ 9,700 total points expected to be redeemed) ×
$8,676 initial allocation] – $4,110 recognized in the
first reporting period}. The contract liability balance
is $1,073 ($8,676 initial allocation – $7,603 of
cumulative revenue recognized).
Loyalty programs allow customers to accumulate points upon each
purchase of goods or services; the points accumulated may then be redeemed to
obtain future goods or services from the same vendor. That is, the customer is
granted an option to purchase additional goods or services by redeeming the
points. Accordingly, ASC 606-10-25-18(j) requires the option to be recognized as
a distinct performance obligation when the option provides the customer with a
material right as defined in ASC 606-10-55-41 through 55-45.
We believe that the existence of an accumulation feature in a
loyalty program is a strong indicator of a material right, to which an entity
would need to allocate a portion of the current contract’s transaction price. We
expect it to be a rare conclusion that loyalty programs with accumulation
features are not material rights.
In circumstances in which a customer’s loyalty points accumulate
with each transaction, the entity should evaluate the current, past, and future
transactions made by the customer in evaluating whether the loyalty program
provides the customer with a material right. In addition, the entity should
consider both qualitative and quantitative factors and, in particular, should
consider whether the material right accumulates over time (after multiple
transactions). That is, the entity should consider factors related to both the
current transaction and the loyalty program in its entirety when analyzing
whether an option provides a material right (and should therefore be accounted
for as a distinct performance obligation in accordance with ASC 606-10-25-18(j)
and ASC 606-10-55-41 through 55-45).
For example, in any given transaction, the number of loyalty points awarded may
not be quantitatively material; however, the structure of the loyalty program
could be designed to influence customer behavior and therefore be a qualitative
indicator that the option provides a material right.
The above issue is addressed in Implementation Q&A 12 (compiled from
previously issued TRG Agenda Papers 6 and 11). For additional information and
Deloitte’s summary of issues discussed in the Implementation Q&As, see
Appendix C.
Note that the above discussion focuses on loyalty programs in which points that a
customer has earned by purchasing goods or services from a vendor are redeemed
for future goods or services from the same vendor. For loyalty programs in which
accumulated points can be redeemed for goods or services from a third party or
for goods or services from the original vendor that meet the requirement to be a
separate performance obligation, the original vendor should evaluate upon
redemption whether it is acting as a principal or as an agent in the transaction
associated with the deferred recognition of revenue. (See Chapter 10 for additional considerations related
to the assessment of whether an entity is a principal or an agent.) For example,
suppose that Company X, an airline, offers one point for every $100 a customer
spends. The accumulated points can be redeemed for either future flights
provided by X or future hotel stays with Hotel Y, a vendor with which X has
partnered. Since X has determined that its loyalty programs offer a material
right that is a performance obligation, X defers a portion of revenue for the
redemption of the loyalty points. Upon a customer’s redemption of points for
either a flight or a hotel stay, X evaluates whether it is acting as a principal
or as an agent in that transaction.
Further, any changes to an entity’s incentives (e.g., loyalty programs, rebates,
method of redeeming points, amounts for which points are earned) should be
evaluated under the contract modification guidance discussed in Chapter 9.
11.2.3 Considering the Class of Customer in the Evaluation of Whether a Customer Option Gives Rise to a Material Right
As noted in Section
11.2.2, when determining whether a material right exists, an entity
should take into account past, current, and future transactions as well as both
qualitative and quantitative factors (including whether the right
accumulates).
ASC 606-10-55-42 states, in part, that an “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
geographic area or market).”
Stakeholder views have differed regarding how the class of
customer should be considered in an entity’s evaluation of whether a customer
option gives rise to a material right. Implementation Q&A 14 (compiled from
previously issued TRG Agenda Papers 54 and 55) and TRG Agenda Paper 54 provide the
following examples of the FASB staff’s views on this topic:
|
Example
|
Facts
|
FASB Staff Analysis and Views
|
|---|---|---|
|
Volume discounts
|
|
Company A will need to consider all
relevant facts and circumstances (including the price
charged to other high-volume customers) to determine
whether the price offered in year 2 represents the
stand-alone selling price for the part. Said
differently, A would need to determine whether the
discount (1) is incremental to the discount that would
be offered to other similar customers (such as that
offered to C) and (2) would be offered to a similar
customer independently of any prior contract the
customer had with A. Company A would not consider
pricing offered to other customers that is contingent on
prior-year volume purchases.
Pricing offered to B that is comparable
to pricing offered to other similar customers (and is
offered independently of prior contracts with A) may be
an indication that there is no incremental discount and
therefore no material right. However, pricing that is
not comparable may be an indication that a material
right has been given to B because B has prepaid for
parts in year 2.
|
|
Tier status
|
|
The airline needs to evaluate whether
the ticket purchase (the contract) includes a material
right by determining whether the customer’s option to
receive discounted goods (e.g., a free checked bag) is
independent of the current contract with the customer.
In other words, the airline would need to consider
whether the benefits (e.g., discounts) given under a
tier status program are incremental to discounts given
to a similar class of customer who did not enter into a
prior contract with the airline. In performing the
evaluation, the company could:
The airline would not consider the price
charged to other customers who received status benefits
through prior contracts with the airline since doing so
would not help it determine whether such discounted
pricing is offered independently of the current
contract.
|
The FASB staff noted that an entity will be required to use
significant judgment to determine whether a material right is provided to the
entity’s customers. Further, the staff noted that it “is not in a position to
reach broad conclusions about these types of fact patterns because there are
many variations of contracts and variations in facts and circumstances that can
affect the conclusion in each fact pattern.”3 However, the staff emphasized the following:
-
The relative importance placed on the considerations discussed in the examples (or other considerations) will vary on the basis of an entity’s facts and circumstances.
-
The objective of the guidance in ASC 606-10-55-42 and 55-43 is to determine whether a customer option to receive discounted goods is independent of an existing contract with a customer.
TRG members debated the application of concepts in the framework
the staff used to analyze the examples in Implementation Q&A 14 and TRG
Agenda Paper 54 but did not reach general agreement on (1) how or when to
consider past transactions in determining the class of customer and (2) how the
class of customer should be evaluated in the determination of the stand-alone
selling price of an optional good or service.
A few TRG members maintained that discounts or status achieved
through past transactions is akin to accumulating features in loyalty programs
(and that such features therefore represent material rights). However, others
indicated that these programs represent marketing inducements (i.e., discounts)
for future transactions that should be evaluated in relation to those offered to
other similar customers or potential customers (e.g., other high-volume
customers or potential high-volume customers). The TRG members who viewed the
programs as marketing inducements believed that considering a customer’s past
transactions, among other factors, is appropriate in the evaluation of whether a
good or service being offered to the customer reflects the stand-alone selling
price for that class of customer in accordance with ASC 606-10-55-42
(particularly for entities that have limited alternative sources of information
available upon which to establish a customer’s class). Further, these TRG
members focused on the facts that (1) similar discounts on future transactions
(like those provided in the form of benefits and other offers in status programs
for no additional fees) may be given to other customers who did not make or have
the same level of prior purchases with the entity and (2) such discounts may be
provided at the stand-alone selling price for that class of customer (i.e., the
good or service is not priced at a discount that is incremental to the range of
discounts typically offered to that class of customer and therefore do not
represent a material right).
Following its stakeholder outreach, the FASB staff indicated
that an entity should evaluate whether tier status programs contain material
rights or represent a marketing incentive. In making this evaluation, the FASB
staff indicated that entities should consider whether discounts offered on
future goods or services to customers within a given tier of a status program
are incremental to the range of discounts typically given to that class of
customer. If an entity never provides customers with tier status other than
through past purchases, the discounts provided to customers under the program
are likely to be material rights. However, if an entity sometimes provides tier
status to customers for reasons other than past purchases, the discounts may be
marketing incentives provided to a particular class of customer. The
determination of whether discounts under a tier status program are material
rights or marketing incentives will require judgment based on an evaluation of
the specific facts and circumstances of the specific program.
Footnotes
1
ASC 606-10-25-2 and ASC 606-10-55-42.
2
A material right arises from pricing on an option to
acquire additional goods or services in the future that would not have
been received if the initial contract had not been entered into. In such
cases, the customer with the option has essentially prepaid for the
future purchase.
3
Quoted from Implementation Q&A 14.
11.3 Optional Purchases Versus Variable Consideration
When an entity enters into a contract to deliver a variable volume
of goods or services, the entity should first determine whether the nature of its
promise is to provide an option to purchase additional goods or services. However,
in some contracts with customers, it may be difficult to differentiate between an
option to purchase additional goods or services (which the entity would need to
evaluate to determine whether a material right — and, therefore, a separate
performance obligation — exists) and variable consideration in the transaction price
that is driven by variable volumes (i.e., the additional volumes are part of a
single performance obligation). When determining the nature of its promise in such
arrangements, an entity should consider the following:
-
If the customer can make a separate purchasing decision to buy additional distinct goods or services (or change the goods or services to be delivered) and the entity is not presently obligated to provide those goods or services before the customer exercises its rights, the customer’s ability to make that separate purchasing decision would be indicative of an option for additional goods or services.
-
Conversely, if future events (which may include the customer’s own actions) will not obligate the vendor to provide additional distinct goods or services (or change the goods or services to be delivered), any additional consideration triggered by those events would instead be variable consideration.
Section 6.3.5.4.1 discusses
considerations related to an entity’s determination of whether a contract contains
optional purchases or variable consideration. Further, Section 12.3.3 discusses optional purchases in
a licensing scenario.
11.4 Likelihood That an Option for Additional Goods or Services Will Be Exercised
Stakeholders have raised various issues related to whether an entity
should assess optional purchases provided to customers to determine whether the
customer is economically compelled — or highly likely — to exercise its option(s).
Some business models include arrangements under which a vendor will
sell an up-front good or service and also provide the customer with an option to
purchase other distinct goods or services in the future that are related to the
up-front good or service (e.g., a specialized piece of equipment and an option to
buy specialized consumables that will be needed for its operation). Such
arrangements may include features that result in a degree of economic compulsion
such that there is a very high level of confidence that the customer will exercise
its option.
In such circumstances, when it is highly probable, or even virtually
certain, that the customer will exercise its option, the additional goods or
services should not be treated as performance obligations under the contract.
The treatment of customer options is explained in paragraph BC186 of ASU 2014-09, in
which the FASB and IASB clarified that “the transaction price does not include
estimates of consideration from the future exercise of options for additional goods
or services,” making no reference to the probability that those options will be
exercised.
Accordingly, irrespective of how likely it is that a customer will
choose to purchase additional goods or services, the entity should not treat those
goods or services as performance obligations under the initial contract. Instead,
the entity should evaluate the customer option (in accordance with ASC 606-10-55-41
through 55-45) to determine whether it gives rise to a material right.
The above issue is addressed in Implementation Q&A 21 (compiled from
previously issued TRG Agenda Papers 48 and 49). For additional information and Deloitte’s
summary of issues discussed in the Implementation Q&As, see Appendix C.
11.5 Allocation of Consideration to Material Rights
ASC 606-10
55-44 Paragraph 606-10-32-29
requires an entity to allocate the transaction price to
performance obligations on a relative standalone selling
price basis. If the standalone selling price for a
customer’s option to acquire additional goods or services is
not directly observable, an entity should estimate it. That
estimate should reflect the discount that the customer would
obtain when exercising the option, adjusted for both of the
following:
-
Any discount that the customer could receive without exercising the option
-
The likelihood that the option will be exercised.
55-45 If a customer has a material
right to acquire future goods or services and those goods or
services are similar to the original goods or services in
the contract and are provided in accordance with the terms
of the original contract, then an entity may, as a practical
alternative to estimating the standalone selling price of
the option, allocate the transaction price to the optional
goods or services by reference to the goods or services
expected to be provided and the corresponding expected
consideration. Typically, those types of options are for
contract renewals.
If an entity’s contract with a customer includes a material right in
the form of an option to acquire additional goods or services, ASC 606-10-55-41
through 55-45 require the entity to allocate part of the transaction price to that
right and recognize the associated revenue when those future goods or services are
transferred or when the option expires. The allocation of consideration to all of
the performance obligations in a contract as required in step 4 is performed on the
basis of stand-alone selling prices. As explained in paragraph BC390 of ASU 2014-09,
option pricing models can be used to estimate an option’s stand-alone selling price.
In addition, ASC 606-10-55-45 provides an alternative to estimating the stand-alone
selling price of a customer option when certain criteria are met (discussed in
Section 11.9).
Allocation of the transaction price in step 4 is discussed comprehensively in
Chapter 7.
11.6 Whether There Can Be a Significant Financing Component as a Result of a Material Right
If an entity’s contract with a customer includes a material right in
the form of a customer option for additional goods or services, the entity should
evaluate whether there is a significant financing component as a result of the
option in accordance with ASC 606-10-32-17 and 32-18. A significant financing
component would not exist if, for example, the timing of transfer of additional
goods or services is at the customer’s discretion. In some circumstances, the
practical expedient in ASC 606-10-32-18 may be available.
Example 11-3
Entity C enters into a contract with a
customer under which the customer will receive Product W
immediately and will have the option to purchase Product X
five years later. The customer does not have the discretion
to choose when to exercise the option; rather, the customer
can exercise the option only at the point in time that is
five years after its purchase of Product W. Under the
contract, the customer is required to pay $340 at the outset
and an additional $300 five years later if it chooses to
exercise the option.
The stand-alone selling prices of Product W
and Product X are $200 and $600, respectively. Entity C
concludes that the option to purchase Product X provides the
customer with a material right. However, because the
customer pays for the material right at the outset but can
exercise the option only five years later, C also concludes
that the contract includes a financing component, which it
judges to be significant. Assume C determines that the
present value of the stand-alone selling price of the option
is $155, which it calculates by using a 10 percent interest
rate based on the rate that would be used in a separate
financing transaction between C and the customer and an
approximate 85 percent likelihood that the option will be
exercised.
The entity allocates the $340 transaction
price between Product W and the option as follows:
Accordingly, the entity (1) recognizes
revenue of $192 when Product W is delivered and (2)
recognizes a contract liability of $148 related to the
material right.
Each year, the entity records interest
expense related to the financing component of the material
right at the rate of 10 percent as follows:
Accordingly, over the five-year period, the
entity recognizes total interest expense of $91. This is
added to the price initially allocated to the option of
$148, resulting in a closing balance of $239 at the end of
year 5.
At the end of year 5, the customer exercises
the option and pays an additional $300. The entity applies
the “Alternative A” approach described in Section 11.7 and allocates to Product X the
balance of the material right ($239) and the additional $300
paid. Therefore, it recognizes revenue of $539 when Product
X is delivered.
Accordingly, C records the following journal
entries in each year of the contract:
At contract inception, to recognize
revenue for the transfer of Product W and establish the
contract liability for the customer’s option to purchase
Product X in five years:
At the end of year 1, to recognize
interest expense related to the financing component of
the material right:
At the end of year 2, to recognize
interest expense related to the financing component of
the material right:
At the end of year 3, to recognize
interest expense related to the financing component of
the material right:
At the end of year 4, to recognize
interest expense related to the financing component of
the material right:
At the end of year 5, to recognize
interest expense related to the financing component of
the material right:
At the end of year 5, to recognize
revenue upon the customer’s exercise of the option to
purchase Product X:
The above issue is addressed in Implementation Q&A 35 (compiled from previously issued
TRG Agenda Papers 18, 25, 32, and 34). For additional information and Deloitte’s summary of
issues discussed in the Implementation Q&As, see Appendix C.
11.7 Customer’s Exercise of a Material Right
When a contract with a customer includes a material right in the
form of an option to acquire additional goods or services, an entity may account for
the customer’s subsequent exercise of the material right either as if it were a
separate contract (“Alternative A,” which we generally believe is preferable) or as
if it were the modification of an existing contract (“Alternative B,” which we
believe is acceptable). Those alternatives may be summarized as follows:
-
Alternative A (preferred) — At the time a customer exercises a material right, an entity treats the exercise as a continuation of the original contract such that the additional consideration is allocated only to the additional performance obligation underlying the material right. In effect, therefore, the entity is treating the exercise as if it were a separate contract altogether. Under this alternative, an entity should determine the transaction price of the “new” contract and include any additional consideration to which the entity expects to be entitled as a result of the exercise. This additional consideration, along with the consideration from the original contract that was allocated to the material right, should be allocated to the performance obligation underlying the material right and recognized as revenue when or as this performance obligation is satisfied. That is, the amount allocated to the material right as part of the original contract is added to any additional amounts due (under the “new” contract) as a consequence of the customer’s exercise of the material right, and that total is allocated to the additional goods or services under the “new” contract. The amounts previously allocated to the other goods and services in the original contract are not revised.
-
Alternative B (acceptable) — It is also acceptable to account for the exercise of a material right as a contract modification since it results in a change in the scope and the price of the original contract. An entity should apply the modification guidance in ASC 606-10-25-10 through 25-13.Since we believe that the application of Alternative B may be complex, we recommend that entities consider consulting with their accounting advisers before electing to use this method.
The TRG discussed questions raised by stakeholders about the accounting for a
customer’s exercise of a material right. TRG members generally preferred the view
that an entity would account for the exercise of a material right as a change in the
contract’s transaction price4 such that the additional consideration would be allocated to the performance
obligation underlying the material right and would be recognized when or as the
performance obligation underlying the material right is satisfied. This, in effect,
results in accounting for the exercise of a material right as a separate contract.
However, the TRG also believed that it would be acceptable for an entity to account
for the exercise of a material right as a contract modification5 (which may require reallocation of consideration between existing and future
performance obligations). Contract modifications are discussed in Chapter 9.
The method used should be applied consistently by an entity to
similar types of material rights and under similar facts and circumstances.
The above issue is addressed in Implementation Q&A 15 (compiled from previously issued
TRG Agenda Papers 18, 25, 32, and 34). For additional information and Deloitte’s summary of
issues discussed in the Implementation Q&As, see Appendix C.
Example 11-4
An entity enters into a contract with a
customer to provide Product X for $200 and Service Y for
$100. The contract also includes an option for the customer
to purchase Service Z for $300. The stand-alone selling
prices (SSPs) of Product X, Service Y, and Service Z are
$200, $100, and $450, respectively. The entity concludes
that the option to purchase Service Z at a discount provides
the customer with a material right. The entity’s estimate of
the stand-alone selling price of the material right is
$100.
The entity allocates the $300 transaction
price ($200 for Product X plus $100 for Service Y) to each
performance obligation under the contract as follows:
Subsequently, when the entity has delivered
Product X and has delivered 60 percent of Service Y, the
customer exercises its option to purchase Service Z for
$300.
Alternative A
(Preferred)
The entity updates the transaction price to
reflect the additional consideration receivable from the
customer. The additional $300 payable after the exercise of
the option is added to the amount of $75 that was previously
allocated to the option to purchase Service Z, resulting in
a total of $375. The amount of $375 is recognized as revenue
over the period during which Service Z is transferred.
No change is made to the amount of revenue
allocated to Product X and Service Y. The revenue not yet
recognized with respect to Service Y (40% × $75 = $30) is
recognized as revenue over the remaining period during which
Service Y is transferred to the customer.
Alternative B
(Acceptable)
The entity accounts for the customer’s
exercise of its option to purchase Service Z as a contract
modification. The appropriate accounting will be different
depending on whether the remaining services to be provided
after the modification (i.e., Service Z and the rest of
Service Y) are distinct from those transferred to the
customer before the modification.
Accounting if the
Remaining Services Are Distinct
If the entity determines that the remaining
services to be provided after the modification are distinct
from those transferred to the customer before the
modification, the guidance in ASC 606-10-25-13(a) should be
applied. The revenue already recognized with respect to
Product X ($150) and 60 percent of Service Y ($75 × 60% =
$45) is not adjusted.
After the modification, the revenue not yet
recognized is determined as follows:
The revenue not yet recognized is then
allocated to the remaining performance obligations as
follows:
Therefore, $33 is recognized as the
remaining 40 percent of Service Y is delivered, and $372 is
recognized as Service Z is delivered.
Accounting if the
Remaining Services Are Not Distinct
If the entity determines that the remaining
goods or services are not distinct, the guidance in ASC
606-10-25-13(b) should be applied and a cumulative catch-up
adjustment to revenue for performance obligations satisfied
over time should be recognized on the date of the
modification (no adjustment is made for fully satisfied
performance obligations). The updated transaction price is
allocated between the two performance obligations that are
satisfied over time as if the modification had been in place
at the start of the contract.
The cumulative catch-up adjustment is
recorded because the remaining 40 percent of Service Y is
not distinct from the previously delivered 60 percent of
Service Y (Service Y is distinct from Service Z) and is
determined as follows:
Therefore, the remaining $33 ($82 – $49) is
recognized as the entity performs the remaining 40 percent
of Service Y, and $368 is recognized as Service Z is
delivered.
Footnotes
11.8 Vouchers, Discounts, and Coupons
Some of the more common scenarios in which an entity may provide
options to purchase additional goods or services involve options in the form of
vouchers, discounts, and coupons. The Codification example and sections below
discuss how entities would apply the revenue standard’s guidance on optional
purchases in those scenarios.
ASC 606-10
Example 49 — Option That Provides the
Customer With a Material Right (Discount Voucher)
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.
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.
55-338 To estimate the standalone
selling price of the discount voucher in accordance with
paragraph 606-10-55-44, the entity estimates an 80 percent
likelihood that a customer will redeem the voucher and that
a customer will, on average, purchase $50 of additional
products. Consequently, the entity’s estimated standalone
selling price of the discount voucher is $12 ($50 average
purchase price of additional products × 30 percent
incremental discount × 80 percent likelihood of exercising
the option). The standalone selling prices of Product A and
the discount voucher and the resulting allocation of the
$100 transaction price are as follows:
55-339 The entity allocates $89 to
Product A and recognizes revenue for Product A when control
transfers. The entity allocates $11 to the discount voucher
and recognizes revenue for the voucher when the customer
redeems it for goods or services or when it expires.
11.8.1 Options to Purchase Goods at a Discount — Vouchers Available With or Without the Requirement to Make an Initial Purchase
The example below illustrates how the accounting for the use of a voucher that
provides a customer with a discount could vary depending on whether the customer
is required to make a purchase before receiving the voucher.
Example 11-5
In an effort to increase sales,
Supermarket B offers two separate marketing programs to
its customers:
-
Program 1 — All visitors to B, irrespective of whether they make any other purchases, can pick up a voucher entitling them to a reduction of $1 from the usual $10 selling price of Product X.
-
Program 2 — Customers who purchase Product W for its normal selling price of $7 will receive a voucher entitling them to a reduction of $5 from Product X’s selling price.
Only one voucher can be used for any
purchase of Product X. It has been determined that the
option granted to purchasers of Product W to purchase
Product X for $5 instead of $9 (i.e., the purchase price
when the $1 voucher is redeemed) gives those customers a
material right.
The $1 vouchers issued under Program 1
are not within the scope of ASC 606. Because the
customer does not enter into any enforceable commitment
by picking up a $1 voucher, no contract arises from the
$1 vouchers.
As a result, B should simply treat the
$1 vouchers as a price reduction when customers use the
$1 vouchers to purchase Product X. Therefore, if a
customer uses a $1 voucher to purchase Product X for $9,
the revenue recognized will be $9 since this is the
consideration to which B is entitled in exchange for
Product X (when the $1 vouchers are taken into
account).
However, the $5 voucher issued under
Program 2 is within the scope of ASC 606 because
customers are entitled to the $5 vouchers as part of a
sales transaction (i.e., the contract to purchase
Product W).
Therefore, in accounting for the $5
vouchers, B should consider the guidance in ASC
606-10-55-41 through 55-45 on customer options for
additional goods or services. According to this
guidance, because the option gives the customer a
material right that it would not receive without
entering into the contract, a separate performance
obligation is established.
ASC 606-10-55-44 specifies that entities
should measure this obligation, if it is not directly
observable, by applying an estimate that reflects “the
discount that the customer would obtain when exercising
the option, adjusted for both of the following:
- Any discount that the customer could receive without exercising the option
- The likelihood that the option will be exercised.”
In assessing the stand-alone selling
price of the $5 vouchers, B should consider (1) that
customers not making a purchase could still have claimed
a $1 voucher (i.e., the incremental value of the $5
voucher to the customer would therefore be $4) and (2)
the likelihood that the $5 voucher will be redeemed.
Accordingly, the stand-alone selling
price of the $5 vouchers that will be used to allocate
the transaction price to the performance obligation for
the discount voucher will not exceed the additional
discount of $4, and it may be lower depending on the
proportion of vouchers expected to be redeemed. The
entity recognizes revenue related to the $5 vouchers
when Product X is transferred to a customer, taking into
account the guidance in ASC 606-10-55-46 through 55-49
(discussed in Section
6.4.2.3) on vouchers not expected to be
redeemed.
11.8.2 Stand-Alone Selling Price for Gift Cards That Can Be Purchased Individually or in Combination With Other Goods or Services
The example below illustrates how the stand-alone selling price for gift cards
could vary depending on whether the gift cards are purchased individually or are
bundled with other goods or services.
Example 11-6
Entity T gives away a $10 gift card to
customers if they purchase a particular brand of
headphones. These gift cards are also sold on a
stand-alone basis at face value. Regardless of whether
they are given away or sold, these gift cards are only
redeemable against future music downloads made by
customers from T’s Web site to the value of $10.
Entity T has consistent historical
experience as follows:
-
When sold on a stand-alone basis, the gift cards have a 95 percent redemption rate.
-
When given away to customers who purchase headphones, the gift cards have a 40 percent redemption rate.
Entity T has determined that the gift
cards given to the customers who purchase headphones
provide those customers with a material right.
Accordingly, they give rise to a performance obligation
under the contract to sell the headphones to which part
of the transaction price should be allocated (see ASC
606-10-55-41 through 55-45 for details).
In allocating the transaction price for
purchases of headphones that include a gift card, T
should use a stand-alone selling price for the gift card
that is different from the cash price charged to
customers buying only a gift card. As discussed in
Section 7.3.3.4, different stand-alone
selling prices can arise for the same item when the
sales are in dissimilar circumstances or to dissimilar
customers.
In the scenarios described above, the
circumstances of the purchase of the gift cards can be
seen to be dissimilar. In particular, customers who
purchase the bundle are receiving gift cards regardless
of whether they want the cards, in contrast with
customers who make a conscious decision to purchase a
gift card; and these different circumstances are
reflected in the markedly different redemption
rates.
Accordingly, the stand-alone selling
price of a gift card given away with headphones is not
directly observable; it cannot be assumed to be the same
as the price of a gift card purchased in isolation
because the sales occur in dissimilar circumstances.
When a stand-alone selling price is not directly
observable, it should be estimated in accordance with
ASC 606-10-55-44, with that estimate reflecting both the
discount that the customer will receive on exercising
the option ($10 in the circumstances described above)
and the likelihood that the option will be
exercised.
Consequently, in the circumstances under
consideration and under the assumption that a customer
could not receive any other discount on downloading
music from T (which would also be reflected in the
estimate required by ASC 606-10-55-44), the stand-alone
selling price of a gift card purchased together with a
set of headphones might be assessed as $4 (40 percent of
$10).
11.8.3 Retailer-Sponsored Coupons Provided Immediately After a Purchase Transaction
Retail stores sometimes provide retailer-sponsored coupons to
customers immediately after a customer transaction (sometimes referred to as
“Catalina” coupons). These coupons are printed at the register on the basis of
an automated program and handed to the customer after a purchase is completed.
An automated program connected to the register determines whether to provide
targeted coupons to the customer as a result of various factors, such as items
purchased by the customer or the amount spent. The coupons given to the customer
can be used only in future purchases, often of specified products.
Sometimes, a customer may be capable of knowing in advance that
he or she will be entitled to receive a particular coupon upon making a
purchase. For example, a retailer may have advertised that it is running a
price-matching campaign under which a customer will receive a coupon that
represents the difference between the price paid for the goods purchased and the
price that would have been paid for those same goods if bought from a
competitor. This coupon can then be redeemed against future purchases the
customer makes from the retailer.
Often, however, when a customer makes a purchase, he or she may
have little or no expectation of either receiving a coupon from the retailer or
being able to obtain particular goods by using such a coupon.
In accordance with ASC 606-10-55-42, the coupon would give rise
to a performance obligation only if it provides a material right that the
customer would not receive without entering into the transaction. This implies
that the discount on the future good or service typically should be part of the
negotiated exchange under the existing contract with the customer. To determine
whether the offer is part of the negotiated exchange under the existing
contract, the retailer would look to ASC 606-10-25-16, which states, in part:
[T]he promised goods and services identified in a contract
with a customer may not be limited to the goods or services that are
explicitly stated in that 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.
An entity will therefore need to use judgment under the
particular facts and circumstances to ascertain whether it has made a promise
(e.g., through advertising campaigns or its customary business practices) that
has created a reasonable expectation on the part of a customer that he or she
will receive a particular coupon upon making a purchase. An entity may also wish
to consider the historical data on how many customers use the coupon for
discounts on future purchases as part of its assessment of whether the coupon
has a significant value to the customer and might therefore provide a material
right.
In the price-matching campaign example described above, it is
possible that the coupon to be redeemed against future purchases may give rise
to a material right as part of the initial sale (see ASC 606-10-55-42 and 55-43
and Section 11.2
for guidance on making this determination) if the price-matching campaign has
created a valid expectation on the part of the customer that he or she will
receive a coupon for any excess amount paid as part of the current
transaction.
However, if the customer has little or no expectation regarding
any coupons that he or she might receive from the retailer, it is unlikely that
a material right exists as part of the initial sale. In particular, the
possibility that the customer will receive a coupon for a discount on future
purchases when making a purchase is unlikely to have influenced the customer’s
buying decision to any meaningful extent. In such cases, the coupon is instead
similar to a targeted coupon distribution based on customer purchasing habits.
Such a coupon should be accounted for at the time of redemption in accordance
with ASC 606-10-32-27, which states:
[I]f consideration
payable to a customer is accounted for as a reduction of the transaction
price, an entity shall recognize the reduction of revenue when (or as) the
later of either of the following events occurs:
-
The entity recognizes revenue for the transfer of the related goods or services to the customer.
-
The entity pays or promises to pay the consideration (even if the payment is conditional on a future event). That promise might be implied by the entity’s customary business practices.
11.9 Renewal Options
Paragraph BC391 of ASU 2014-09 explains that contracts could
describe renewal options as either (1) renewal options, which are basically
extensions of the current contract, or (2) early cancellations, which are the option
for a customer to end a long contract earlier than planned. A customer option to
renew could be considered an option for additional goods or services, which then
opens the door for the entity to consider whether the option is a material right
(i.e., a performance obligation).
When options for additional goods or services are considered
material rights, an entity is required to estimate the options’ stand-alone selling
price so that consideration from the contract can be allocated to the options. Since
renewal options are similar to options for additional goods or services, an entity
would have to determine an estimate of the options’ stand-alone selling price for
each renewal period, which may be complex.
However, as explained in paragraphs BC392 through BC395 of ASU
2014-09, the FASB and IASB decided to provide a practical alternative for renewal
options that allows an entity to “include the optional goods or services that it
expects to provide (and corresponding expected customer consideration) in the
initial measurement of the transaction price.” This practical alternative is
included in ASC 606-10-55-45, which states:
If a customer has a material right to
acquire future goods or services and those goods or services are similar to the
original goods or services in the contract and are provided in accordance with
the terms of the original contract, then an entity may, as a practical
alternative to estimating the standalone selling price of the option, allocate
the transaction price to the optional goods or services by reference to the
goods or services expected to be provided and the corresponding expected
consideration. Typically, those types of options are for contract renewals.
To differentiate contract renewal options from other types of options for additional
goods or services (the latter of which are not eligible for the practical
alternative if the optional goods or services are not similar to the original goods
or services in the contract), the boards developed two criteria that must be met for
an entity to apply the practical alternative:
-
The additional goods or services in the renewal options are similar to those provided in the initial contract.
-
The renewal options’ terms and conditions related to goods or services are the same as those of the original contract.
These concepts are illustrated by Example 51 in ASC 606.
ASC 606-10
Example 51 — Option That Provides the
Customer With a Material Right (Renewal Option)
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.
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 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.
55-345 The renewal option is for a
continuation of maintenance services, and those services are
provided in accordance with the terms of the existing
contract. Instead of determining the standalone selling
prices for the renewal options directly, the entity
allocates the transaction price by determining the
consideration that it expects to receive in exchange for all
the services that it expects to provide in accordance with
paragraph 606-10-55-45.
55-346 The entity expects 90
customers to renew at the end of Year 1 (90 percent of
contracts sold) and 81 customers to renew at the end of Year
2 (90 percent of the 90 customers that renewed at the end of
Year 1 will also renew at the end of Year 2, that is 81
percent of contracts sold).
55-347 At contract inception, the
entity determines the expected consideration for each
contract is $2,710 [$1,000 + (90 percent × $1,000) + (81
percent × $1,000)]. The entity also determines that
recognizing revenue on the basis of costs incurred relative
to the total expected costs depicts the transfer of services
to the customer. Estimated costs for a three-year contract
are as follows:
55-348 Accordingly, the pattern of
revenue recognition expected at contract inception for each
contract is as follows:
55-349 Consequently, at contract
inception, the entity allocates to the option to renew at
the end of Year 1 $22,000 of the consideration received to
date [cash of $100,000 – revenue to be recognized in Year 1
of $78,000 ($780 × 100)].
55-350 Assuming there is no change
in the entity’s expectations and the 90 customers renew as
expected, at the end of the first year, the entity has
collected cash of $190,000 [(100 × $1,000) + (90 × $1,000)],
has recognized revenue of $78,000 ($780 × 100), and has
recognized a contract liability of $112,000.
55-351 Consequently, upon renewal
at the end of the first year, the entity allocates $24,300
to the option to renew at the end of Year 2 [cumulative cash
of $190,000 – cumulative revenue recognized in Year 1 and to
be recognized in Year 2 of $165,700 ($78,000 + $877 ×
100)].
55-352 If the actual number of
contract renewals was different than what the entity
expected, the entity would update the transaction price and
the revenue recognized accordingly.
The example below further illustrates how to allocate consideration
to renewal options that provide material rights to a customer.
Example 11-7
ABC Company enters into 100 separate
contracts with customers to provide a perpetual software
license for $10,000 and one year of PCS for $1,000. The
contracts include a customer option to renew PCS for an
additional year for $500. ABC Company concluded that the
renewal option represents a material right and the license
and PCS are distinct performance obligations. ABC Company
also determined that both the perpetual license and PCS were
sold at stand-alone selling prices and estimated that the
customer has a 75 percent probability of renewing at the end
of year 1, 50 percent at the end of year 2, 25 percent at
the end of year 3, and 0 percent at the end of year 4.
Stand-Alone Selling
Price Approach
Year 1 renewal = $375, or ($1,000 − $500) ×
75%
Year 2 renewal = $250, or ($1,000 − $500) ×
50%
Year 3 renewal = $125, or ($1,000 − $500) ×
25%
As a result of applying the stand-alone
selling price approach, ABC Company would allocate $702
($351 + $234 + $117) to the material right. In addition, ABC
Company would recognize $10,298 ($9,362 + $936) in year
1.
“Look Through” Approach
If ABC Company chose to apply the practical
alternative or “look through” approach,6 the company would estimate a hypothetical transaction
price in one of two ways. The first approach is to determine
the best estimate of the number of years that a customer
would renew. Assume in this case that the company’s best
estimate is that the customer will exercise the renewal
option for two years.
This would result in recognition of $10,154
in revenue in year 1 ($9,231 + $923) and a deferral of $846
($11,000 − $10,154) related to the material right.
However, in a manner consistent with Example
51 in ASC 606,7 an entity could also use a portfolio approach to
estimate the hypothetical transaction price in the “look
through” model. Under this approach, the entity would use
the same probabilities applied in the stand-alone selling
price model to determine the hypothetical transaction price.
The following table illustrates this approach:
This would result in recognition of $9,233
in revenue in year 1 ($8,394 + $839) and a deferral of
$1,767 ($11,000 − $9,233) related to the material right.
Note, however, that when a portfolio
approach is applied, individual cancellations would not
necessarily result in an immediate adjustment. This is
because the overall estimates would incorporate a level of
cancellations each period. It is only when the cancellation
pattern of the overall portfolio changes that an entity
would assess a potential change in estimate.
Connecting the Dots
Television studios often enter into contracts with
broadcasters for the broadcast of the first season of a new television show,
with an exclusive pickup option for the broadcaster to license any
subsequent seasons of the show for a fixed fee per season. After contract
inception, the value of this option may change depending on the success of
the first season.
In accordance with ASC 606-10-55-42, a material right exists
if the fixed fee for the option reflects a discount that would not have been
offered if the broadcaster had not purchased the license for the first
season. Conversely, in accordance with ASC 606-10-55-43, a material right
does not exist if the fixed fee for the option represents the option’s
stand-alone selling price at contract inception.
In the circumstances described, it may be difficult to
estimate the stand-alone selling price of the option (because options of
this type are not typically sold separately and their value is affected by
the likelihood of success of the initial season, which may be unknown at
contract inception). Consequently, entities will need to use judgment in
making this evaluation. Although the value of such an option may
subsequently increase if a show is successful, whether there is a material
right should be assessed only by reference to the value of that option at
contract inception.
Footnotes
6
ABC Company is eligible to apply the practical
alternative since the optional purchase is for
additional goods or services that are similar to the
original goods or services in the contract.
Specifically, the PCS subject to the renewal option
is the same PCS included in the original
contract.
7
ASC 606-10-55-343 through
55-352.
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 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
95,000 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 70,000:8
$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).
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
8
As a result, 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.
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.