13.2 Costs of Obtaining a Contract

ASC 340-40

15-2 The guidance in this Subtopic applies to the incremental costs of obtaining a contract with a customer within the scope of Topic 606 on revenue from contracts with customers (excluding any consideration payable to a customer, see paragraphs 606-10-32-25 through 32-27).

ASC 340-40 provides an overall, comprehensive framework to account for costs of obtaining a contract that are within the scope of ASC 606. That is, if a contract falls within the scope of ASC 606, an entity should look to ASC 340-40 for all relevant guidance on costs of obtaining the contract.

Specifically, ASC 340-40 provides the following guidance on recognizing the incremental costs of obtaining a contract with a customer:

ASC 340-40

25-1 An entity shall recognize as an asset the incremental costs of obtaining a contract with a customer if the entity expects to recover those costs.

25-2 The incremental costs of obtaining a contract are those costs that an entity incurs to obtain a contract with a customer that it would not have incurred if the contract had not been obtained (for example, a sales commission).

25-3 Costs to obtain a contract that would have been incurred regardless of whether the contract was obtained shall be recognized as an expense when incurred, unless those costs are explicitly chargeable to the customer regardless of whether the contract is obtained.

The flowchart below illustrates the process that entities should use in applying the guidance in ASC 340-40-25-1 through 25-3 to determine the treatment of costs of obtaining a contract with a customer.

13.2.1 General Considerations for Identifying Incremental Costs of Obtaining a Contract With a Customer

ASC 340-40-25-2 states that the “incremental costs of obtaining a contract are those costs that an entity incurs to obtain a contract with a customer that it would not have incurred if the contract had not been obtained (for example, a sales commission).” Application of this guidance requires an entity to identify those costs that are incurred (i.e., accrued) as a direct result of obtaining a contract with a customer. An entity should apply existing guidance outside of the revenue standard to determine whether a liability should be recognized as a result of obtaining a contract with a customer. Upon determining that a liability needs to be recorded, the entity should determine whether the related costs were incurred because, and only because, a contract with a customer was obtained.

In many circumstances, it may be clear whether particular costs are costs that an entity incurs to obtain a contract. For example, if an entity incurs a commission liability solely as a result of obtaining a contract with customer, the commission would be an incremental cost incurred to obtain a contract with a customer. However, in other circumstances, an entity may need to exercise judgment and consider existing accounting policies for liability accruals when determining whether a cost is incurred in connection with obtaining a contract with a customer. If the determination of whether a cost has been incurred is affected by other factors (i.e., factors in addition to obtaining a contract with a customer), an entity will need to take additional considerations into account when assessing whether a cost is an incremental cost associated with obtaining a contract with a customer.

Examples 1 and 2 in ASC 340-40 illustrate how to identify incremental costs of obtaining a contract.

ASC 340-40

Example 1 — Incremental Costs of Obtaining a Contract

55-2 An entity, a provider of consulting services, wins a competitive bid to provide consulting services to a new customer. The entity incurred the following costs to obtain the contract:

55-3 In accordance with paragraph 340-40-25-1, the entity recognizes an asset for the $10,000 incremental costs of obtaining the contract arising from the commissions to sales employees because the entity expects to recover those costs through future fees for the consulting services. The entity also pays discretionary annual bonuses to sales supervisors based on annual sales targets, overall profitability of the entity, and individual performance evaluations. In accordance with paragraph 340-40-25-1, the entity does not recognize an asset for the bonuses paid to sales supervisors because the bonuses are not incremental to obtaining a contract. The amounts are discretionary and are based on other factors, including the profitability of the entity and the individuals’ performance. The bonuses are not directly attributable to identifiable contracts.

55-4 The entity observes that the external legal fees and travel costs would have been incurred regardless of whether the contract was obtained. Therefore, in accordance with paragraph 340-40-25-3, those costs are recognized as expenses when incurred, unless they are within the scope of another Topic, in which case, the guidance in that Topic applies.

Example 2 — Costs That Give Rise to an Asset

55-5 An entity enters into a service contract to manage a customer’s information technology data center for five years. The contract is renewable for subsequent one-year periods. The average customer term is seven years. The entity pays an employee a $10,000 sales commission upon the customer signing the contract. Before providing the services, the entity designs and builds a technology platform for the entity’s internal use that interfaces with the customer’s systems. That platform is not transferred to the customer but will be used to deliver services to the customer.

Incremental Costs of Obtaining a Contract

55-6 In accordance with paragraph 340-40-25-1, the entity recognizes an asset for the $10,000 incremental costs of obtaining the contract for the sales commission because the entity expects to recover those costs through future fees for the services to be provided. The entity amortizes the asset over seven years in accordance with paragraph 340-40-35-1 because the asset relates to the services transferred to the customer during the contract term of five years and the entity anticipates that the contract will be renewed for two subsequent one-year periods.

The FASB staff noted that the accounting for sales commissions is generally straightforward in situations in which (1) the commission is a fixed amount or a percentage of contract value and (2) the contract is not expected to be (or cannot be) renewed. However, if compensation plans or other costs incurred are complex, it may be difficult to determine which costs are truly incremental and to estimate the period of amortization related to them.

Examples of complex scenarios include:

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

Stakeholders expressed concerns that the term “incremental” could lead to broad interpretations of the types of costs that would qualify as costs to be capitalized under the revenue standard. In response to those concerns, the FASB staff noted the following:

An entity should consider whether costs would have been incurred if the customer (or the entity) decided that it would not enter into the contract just as the parties were about to sign the contract. If the costs (e.g., the legal costs of drafting the contract) would have been incurred even though the contract was not executed, the costs would not be incremental costs of obtaining a contract.
When an entity is identifying incremental costs incurred to obtain a contract, it may be important for the entity to first consider guidance outside of the revenue standard on determining whether and, if so, when a liability has been incurred. That is, other guidance will generally determine when a cost has been incurred, while ASC 340-40 provides guidance on determining whether costs should be capitalized or expensed.
When sales commissions are paid to different levels of employees, the revenue standard does not differentiate among the commissions on the basis of the employees’ respective functions or titles. For example, if an entity’s commission policy on new contracts was to pay 10 percent sales commission to the sales employee, 5 percent to the sales manager, and 3 percent to the regional sales manager, all of the commissions are viewed as incremental because the commissions would not have been incurred if the contract had not been obtained.

Entities should continue to refer to existing U.S. GAAP on liability recognition to determine whether and, if so, when a liability needs to be recorded in connection with a contract with a customer. Therefore, an entity should initially apply the specific guidance on determining the recognition and measurement of the liability (e.g., commissions, payroll taxes, 401(k) match). If the entity recognizes a liability, only then should the entity determine whether to record the related debit as an asset or as an expense.

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

The table below outlines the views detailed in TRG Agenda Paper 57 and broadly summarized in Q&A 78 of the FASB staff’s Revenue Recognition Implementation Q&As (the “Implementation Q&As”). Quoted text is from TRG Agenda Paper 57.

Topic	Example/Question	Views Discussed	View Selected by FASB Staff
Fixed employee salaries	“Example 1: An entity pays an employee an annual salary of $100,000. The employee’s salary is based upon the employee’s prior-year signed contracts and the employee’s projected signed contracts for the current year. The employee’s salary will not change based on the current year’s actual signed contracts; however, salary in future years likely will be impacted by the current year’s actual signed contracts. What amount, if any, should the entity record as an asset for incremental costs to obtain a contract during the year?”	View A: “Determine what portion of the employee’s salary is related to sales projections and allocate that portion of the salary as an incremental cost to obtain a contract.” View B: “Do not capitalize any portion of the employee’s salary as an incremental cost to obtain a contract. The costs are not incremental costs to any contract because the costs would have been incurred regardless of the employee’s signed contracts in the current year.”	View B. “[N]one of the employee’s salary should be capitalized as an incremental cost to obtain a contract. . . . Whether the employee sells 100 contracts, 10 contracts, or no contracts, the employee is still only entitled to a fixed salary.” “[T]he objective of the requirements in [ASC] 340-40-25-1 is not to allocate costs that are associated in some manner with an entity’s marketing and sales activity. The objective is to identify the incremental costs that an entity would not have incurred if the contract had not been obtained.”
Some, but not all, costs are incremental	“Example 2: An entity pays a 5% sales commission to its employees when they obtain a contract with a customer. An employee begins negotiating a contract with a prospective customer and the entity incurs $5,000 of legal and travel costs in the process of trying to obtain the contract. The customer ultimately enters into a $500,000 contract and, as a result, the employee receives a $25,000 sales commission. What amount should the entity capitalize as an incremental cost to obtain the contract?”	View A: “The entity should capitalize only $25,000 for the sales commission. Those costs are the only costs that are incremental costs to obtain the contract because the entity would not have incurred the costs if the contract had not been obtained.” View B: “The entity should capitalize $30,000, which includes the sales commission, legal expenses, and travel expenses. The entity would not have been able to obtain the contract without incurring those expenses.”	View A. “[T]he sales commission is the only cost that the entity would not have incurred if the contract had not been obtained. While the entity incurs other costs that are necessary to facilitate a sale (such as legal, travel and many others), those costs would have been incurred even if the customer decided at the last moment not to execute the contract.” Consider a similar situation in which an entity “incurs the same type of legal and travel expenses to negotiate a contract, but the customer decides not to enter into the contract right before the contract was to be signed by both parties. [T]he travel and legal expenses would still have been incurred even though the contract was not obtained. However, the commission would not have been incurred.”
Timing of commission payments	“Example 3: An entity pays an employee a 4% sales commission on all of the employee’s signed contracts with customers. For cash flow management, the entity pays the employee half of the commission (2% of the total contract value) upon completion of the sale, and the remaining half of the commission (2% of the total contract value) in six months. The employee is entitled to the unpaid commission, even if the employee is no longer employed by the entity when payment is due. An employee makes a sale of $50,000 at the beginning of year one. What amount should the entity capitalize as an incremental cost to obtain the contract?”	View A: “Capitalize half of the commission ($1,000) and expense the other half of the commission ($1,000).” View B: “Capitalize the entire commission ($2,000).”	View B. “The commission is an incremental cost that relates specifically to the signed contract and the employee is entitled to the unpaid commission. [T]he timing of payment does not impact whether the costs would have been incurred if the contract had not been obtained.” “In this fact pattern, only the passage of time needs to occur for the entity to pay the second half of the commission. However, . . . there could be other fact patterns in which additional factors might impact the payment of a commission to an employee.” For example, an entity could make the second half of the commission contingent upon the employee’s selling additional services to the customer or upon the customer’s “completing a favorable satisfaction survey about its first six months of working with the entity.” Therefore, an “entity will need to assess its specific compensation plans to determine the appropriate accounting for incremental costs of obtaining a contract.”
Commissions paid to different levels of employees	“Example 4: An entity’s salesperson receives a 10% sales commission on each contract that he or she obtains. In addition, the following employees of the entity receive sales commissions on each signed contract negotiated by the salesperson: 5% to the manager and 3% to the regional manager. Which commissions are incremental costs of obtaining a contract?”	View A: “Only the commission paid to the salesperson is considered incremental because the salesperson obtained the contract.” View B: “Only the commissions paid to the salesperson and the manager are considered incremental because the other employee likely would have had no direct contact with the customer.” View C: “All of the commissions are incremental because the commissions would not have been incurred if the contract had not been obtained.”	View C. “The new revenue standard does not make a differentiation based on the function or title of the employee that receives the commission. It is the entity that decides which employee(s) are entitled to a commission directly as a result of entering into a contract.” “[I]t is possible that several commissions payments are incremental costs of obtaining the same contract. However, [stakeholders are encouraged] to ensure that each of the commissions are incremental costs of obtaining a contract with a customer, rather than variable compensation (for example, a bonus)” that would not be incremental because it also relies on factors other than sales.
Commission payments subject to a threshold	“Example 5: An entity has a commission program that increases the amount of commission a salesperson receives based on how many contracts the salesperson has obtained during an annual period. The breakdown is as follows: 0-9 contracts . . . 0% commission 10-19 contracts . . . 2% of value of contracts 1-19 20+ contracts . . . 5% of value of contracts 1-20+ Which commissions are incremental costs of obtaining a contract?”	View A: “No amounts should be capitalized because the commission is not directly attributable to a specific contract.” View B: “The costs are incremental costs of obtaining a contract with a customer and, therefore, the costs should be capitalized.”	View B. Both the 2 percent commission and the 5 percent commission are incremental costs of obtaining a contract. “The entity would apply other GAAP to determine whether a liability for the commission payments should be recognized. When a liability is recognized, the entity would recognize a corresponding asset for the commissions. This is because the commissions are incremental costs of obtaining a contract with a customer. The entity has an obligation to pay commissions as a direct result of entering into contracts with customers. The fact that the entity’s program is based on a pool of contracts (versus a program in which the entity pays 3% for all contracts) does not change the fact that the commissions would not have been incurred if the entity did not obtain the contracts with those customers.”

The above issue is addressed in Implementation Q&A 78 (compiled from previously issued TRG Agenda Papers 57 and 60). For additional information and Deloitte’s summary of issues discussed in the Implementation Q&As, see Appendix C.

13.2.2 Sales Commissions and Compensation Structures

Commissions are often cited as an example of an incremental cost incurred to obtain a contract. Acknowledging that it may be difficult for an entity to determine whether a commission paid was incremental to obtaining the new contract, the boards considered permitting a policy election that would allow an entity to choose to recognize the acquisition costs as either an asset or an expense. However, such an election would be contrary to the goal of increasing comparability, which is one of the key objectives of the revenue standard; therefore, the boards ultimately decided not to allow an accounting policy election for costs of obtaining a contract. See Sections 14.6.3 and 14.7.4 for discussion of the presentation of contract costs in an entity’s classified balance sheet and income statement, respectively.

Some commission plans include substantive service conditions that need to be met before a commission associated with a contract (or group of contracts) is actually earned by the salesperson. In such cases, some or all of the sales commission may not be incremental costs incurred to obtain a contract with the customer since the costs were not actually incurred solely as a result of obtaining a contract with a customer. Rather, the costs were incurred as a result of obtaining a contract with a customer and the salesperson’s providing ongoing services to the entity for a substantive period.

A commission structure could have a service condition that is determined to be nonsubstantive. In such a case, the commission is likely to be an incremental cost incurred to obtain a contract with a customer if no other conditions need to be met for the salesperson to earn the commission. In other cases, a commission plan could include a service condition, but the reporting entity determines on the basis of the amount and structure of the commission payments that part of the entity’s commission obligation is an incremental cost incurred to obtain a contract with a customer (because it is not tied to a substantive service condition) while the rest of the commission is associated with ongoing services provided by the salesperson (because it is tied to a substantive service condition).

Sometimes, there may be other factors that affect the commission obligation, but the ultimate costs are still incremental costs incurred to obtain the contract. For example, a commission may be payable to a salesperson if a customer’s total purchases exceed a certain threshold regardless of whether the salesperson is employed when the threshold is met (i.e., there is no service condition). In these cases, although no liability may be recorded when the contract with the customer is obtained (because of the entity’s assessment of the customer’s likely purchases), if the customer’s purchases ultimately exceed the threshold and the commission is paid, the commission is an incremental cost of obtaining the contract. That is, the commission is a cost that the entity would not have incurred if the contract had not been obtained. This situation is economically similar to one involving a paid commission that is subject to clawback if the customer does not purchase a minimum quantity of goods or services.

Entities will need to carefully evaluate the facts and circumstances when factors other than just obtaining a contract with a customer affect the amount of a commission or other incurred costs. Entities should consider their existing policies on accruing costs when determining which costs are incremental costs incurred to obtain a contract with a customer.

Example 13-1

Entity A’s internal salespeople earn a commission based on a fixed percentage (4 percent) of sales invoiced to a customer. Half of the commission is paid when a contract with a customer is signed; the other half is paid after 12 months, but only if the salesperson is still employed by A. Entity A concludes that there is a substantive service period associated with the second commission payment, and A’s accounting policy is to accrue the remaining commission obligation ratably as the salesperson provides ongoing services to A.

Entity A enters into a three-year noncancelable service contract with a customer on January 1, 20X7. The total transaction price of $3 million is invoiced on January 1, 20X7. The salesperson receives a commission payment of 2 percent of the invoice amount ($60,000) when the contract is signed; the other half of the 4 percent commission will be paid after 12 months if the salesperson continues to be employed by A at that time. That is, if the salesperson is not employed by A on January 1, 20X8, the second commission payment will not be made. Entity A records a commission liability of $60,000 on January 1, 20X7, and accrues the second $60,000 commission obligation ratably over the 12-month period from January 1, 20X7, through December 31, 20X7.

Entity A concludes that only the first $60,000 is an incremental cost incurred to obtain a contract with a customer. Because there is a substantive service condition associated with the second $60,000 commission, A concludes that the additional cost is a compensation cost incurred in connection with the salesperson’s ongoing service to A. That is, the second $60,000 commission obligation was not incurred solely to obtain a contract with a customer but was incurred in connection with ongoing services provided by the salesperson.

If the salesperson would be paid the commission even if no longer employed, or if A otherwise concluded that the service condition was not substantive, the entire $120,000 would be an incremental cost incurred to obtain a contract and would be capitalized in accordance with ASC 340-40-25-1. Entities will need to exercise professional judgment when determining whether a service condition is substantive.

Because commission and compensation structures can vary significantly between entities, an entity should evaluate its specific facts and circumstances when determining which costs are incremental costs incurred to obtain a contract with a customer. Since many entities pay sales commissions to obtain contracts with customers, questions have arisen regarding how to apply the revenue standard’s cost guidance to such commissions, including:

Whether certain commissions (e.g., commissions on contract renewals or modifications, commission payments that are contingent on future events, and commission payments that are subject to clawback or thresholds) qualify as assets.
The types of costs to capitalize (e.g., whether and, if so, how an entity should consider fringe benefits such as payroll taxes, pension, or 401(k) match) in determining the amount of commissions to record as incremental costs.
The pattern of amortization for assets related to multiple performance obligations (e.g., for contract cost assets related to multiple performance obligations that are satisfied over disparate points or periods of time).

Entities should continue to first refer to existing U.S. GAAP on liability recognition to determine whether and, if so, when a liability from a contract with a customer needs to be recorded. For example, an entity would apply the specific U.S. GAAP on liability (e.g., commissions, payroll taxes, 401(k) match) and then determine whether to record the related debit as an asset or expense.

In addition, the revenue standard is clear that (1) an entity should amortize the asset on a systematic basis and (2) the method should reflect the pattern of transfer of goods or services to a customer to which the asset is related. That is, the asset should be amortized in a manner that reflects the benefit (i.e., revenue) generated from the asset. For further discussion, see Section 13.4.1.

The above issue is addressed in Implementation Q&As 67 through 75 (compiled from previously issued TRG Agenda Papers 23, 25, 57, and 60). For additional information and Deloitte’s summary of issues discussed in the Implementation Q&As, see Appendix C.

13.2.2.1 Tiered Commissions

Commission plans for a specific employee that involve initial contracts and contract renewals might be established in such a way that (1) the commission is subject to a cumulative contract threshold and (2) commission rates change depending on the number (or cumulative value) of contracts signed. For instance, fixed or percentage commissions may commence or change once a specified threshold is achieved for the cumulative number or value of contracts. The examples below, which are adapted from examples considered by the FASB staff in TRG Agenda Paper 23, illustrate various cumulative threshold scenarios.

Example 13-2

Once a cumulative threshold number of contracts is reached, the entity pays commission on individual contracts as a percentage of the value of each contract in the manner shown in the table below.

Number of Contracts Signed	Commission Rate
1–5	0% commission
6–10	3% of individual contract price
11 or more	5% of individual contract price

Example 13-3

Once a cumulative threshold value of contracts is reached, the entity pays commission on individual contracts as a percentage of the value of each contract in the manner shown in the table below.

Value of Contracts Signed	Commission Rate
First $1 million	0% commission
Next $4 million	3% of individual contract price
More than $5 million	5% of individual contract price

Example 13-4

Once a cumulative threshold number of contracts is reached, the entity pays commission on the last contract as a percentage of the cumulative value of that contract and the preceding contracts in the manner shown in the table below, taking into account any commission already paid.

Number of Contracts Signed	Commission Rate
1–5	0% commission
6	3% of value of contracts 1–6
7–10	0% commission
11 or more	5% of value of all contracts (including commission already paid on contracts 1–6)

Example 13-5

As shown in the table below, the entity pays the first commission when the first contract is signed. Subsequently, once a cumulative threshold number of contracts is reached, the entity pays a commission on the threshold contract that is greater than the commission paid on the initial contract and takes into account any commissions previously paid. In this example, it is assumed that the entity has no history of sales employees’ closing more than 15 new contracts in a period.

Number of Contracts Signed	Commission Amount
1	$ 3,000
10	$ 5,000	cumulative commission (including $3,000 already paid)
15	$ 10,000	cumulative commission (including $5,000 already paid)

Assume that the commissions in all of the examples above are incremental costs incurred to obtain a contract that should be capitalized in accordance with ASC 340-40-25-1.

There are at least two acceptable approaches to determining which commissions are incremental to obtaining a contract in the scenarios described above. One approach (“Approach A”) would be to specifically attribute the incremental costs of each contract to that contract. For example, if no commission is paid until the fifth contract is signed, the commission would be attributed to only the fifth contract. Another approach (“Approach B”) would be to accrue commission for each contract on the basis of the average commission rate expected to be paid under the commission plan. For example, although a commission is paid only once the fifth contract is signed, the commission is earned, and would be accrued, as contracts 1 through 5 are signed. Entities should consider their historical policies for recording commission liabilities when determining which approach to apply.

Under the two alternative approaches, the entity in each of the illustrative examples above should account for the tiered commissions as follows:

Example 13-2:
- Approach A — When the 6th contract is signed, the entity should capitalize 3 percent of the price of that contract and successive contracts as an incremental cost of obtaining a contract until the 11th contract is signed, at which point the entity should capitalize 5 percent of the price of that contract and successive contracts.
- Approach B — The entity should estimate the total amount of commission to be earned for the period and capitalize a ratable amount of commission costs upon the signing of each contract. For example, if the entity estimates that seven contracts, each valued at $10,000, will be signed and therefore the total estimated price of the 6th and 7th contract is $20,000, it estimates the total commission to be capitalized as $600 ($20,000 × 3% commission). Upon the signing of each $10,000 contract, the entity may capitalize $86 of commission ($600 total estimated commission ÷ the 7 expected contracts signed = $86 estimated commission per contract).
Example 13-3:
- Approach A — Upon the signing of the specific contract that results in the aggregate value of over $1 million in contract value, the entity should capitalize 3 percent of the price of that contract and successive contracts as an incremental cost of obtaining a contract until the $5 million aggregate value is reached, at which point the entity should capitalize 5 percent of the price of that contract and successive contracts.
- Approach B — The entity should estimate the total amount of commission to be earned for the period and capitalize a ratable amount of commission costs upon the signing of each contract. For example, if the entity estimates that three contracts will be signed with an aggregate of $4 million in contract value (contract 1 is $1 million, contract 2 is $1 million, and contract 3 is $2 million), the entity will estimate $90,000 in commissions to be capitalized, or ($4 million − $1 million) × 3% commission. The entity may capitalize the relative value for each contract:
  - Contract 1: ($1 million ÷ $4 million) × $90,000 = $22,500.
  - Contract 2: ($1 million ÷ $4 million) × $90,000 = $22,500.
  - Contract 3: ($2 million ÷ $4 million) × $90,000 = $45,000.
Example 13-4:
- Approach A — When the 6th contract is signed, the entity should capitalize 3 percent of the cumulative prices of contracts 1 through 6 as an incremental cost of obtaining the 6th contract. Similarly, when the 11th contract is signed, the entity should capitalize 5 percent of the cumulative prices of contracts 1 through 11 (less the 3 percent previously paid on contracts 1 through 6) as an incremental cost of obtaining the 11th contract. Further, the entity should capitalize 5 percent of the price of each successive contract (beyond the 11th contract) as an incremental cost of obtaining a contract.
- Approach B — The entity should estimate the total amount of commission to be earned for the period and capitalize a ratable amount of commission costs upon the signing of each contract. For example, if the entity estimates that eight contracts will be signed and the estimated cumulative prices of contracts 1 through 6 will be $32,000, it will estimate $960 in commissions to be capitalized ($32,000 × 3% commission). If the price of each contract is the same, the entity may capitalize $120 upon the signing of each contract ($960 total estimated commission ÷ the 8 expected contracts signed = $120 estimated commission per contract).
Example 13-5:
- Approach A — Once the initial contract is signed, the entity should capitalize $3,000 as an incremental cost of obtaining that contract. The entity would not capitalize any additional amounts when contracts 2 through 9 are signed because the next commission “tier” has not been met. Once the 10th contract is signed, the entity should capitalize an additional $2,000. Similarly, the entity would not capitalize any additional amounts when contracts 11 through 14 are signed and should capitalize an additional $5,000 once the 15th contract is signed.
- Approach B — The entity should estimate the total amount of commission to be earned for the period and capitalize a ratable amount of commission costs upon the signing of each contract. For example, if the entity estimates that 11 contracts will be signed and the price of each contract is the same, it may capitalize $455 when each contract is signed ($5,000 ÷ the 11 contracts signed = $455 to be capitalized as the commission amount per contract).

The above issue is addressed in Implementation Q&A 69 (compiled from previously issued TRG Agenda Papers 23 and 25). For additional information and Deloitte’s summary of issues discussed in the Implementation Q&As, see Appendix C.

13.2.2.2 Fringe Benefits

The example below illustrates the determination of whether fringe benefits such as 401(k) match contributions associated with sales commissions should be capitalized as incremental costs of obtaining contracts with customers.

Example 13-6

Entity C has a policy to match 401(k) contributions based on salaries paid to sales representatives, including sales commissions. These sales commissions are determined to meet the definition of incremental costs of obtaining contracts with customers in ASC 340-40-25-2 and are therefore capitalized in accordance with ASC 340-40-25-1.

When 401(k) match contributions (along with other fringe benefits) are attributed directly to sales commissions that are determined to be incremental costs of obtaining contracts with customers, the 401(k) match contributions also qualify as incremental costs of obtaining the contracts since such costs would not have been incurred if the contracts had not been obtained. However, incremental costs of obtaining contracts with customers would not include fringe benefits constituting an allocation of costs that would have been incurred regardless of whether a contract with a customer had been obtained.

The above issue is addressed in Implementation Q&A 74 (compiled from previously issued TRG Agenda Papers 23, 25, 57, and 60). For additional information and Deloitte’s summary of issues discussed in the Implementation Q&As, see Appendix C.

13.2.2.3 Asset Manager Costs

The FASB noted that the treatment of sales commissions paid to third-party brokers in arrangements between asset managers and other parties may vary depending on the facts and circumstances of the arrangement (i.e., the commission would be recognized in some cases as an expense and in other cases as an asset). This outcome was not the FASB’s intent; therefore, the Board decided to retain specific cost guidance for investment companies in ASC 946-605-25-8, which has been moved to ASC 946-720. Further, in December 2016, the FASB issued ASU 2016-20, which aligns the cost capitalization guidance in ASC 946 for advisers to both public funds and private funds (see Chapter 18).

13.2.3 Practical Expedient in ASC 340-40-25-4 for Expensing Contract Acquisition Costs

ASC 340-40

25-4 As a practical expedient, an entity may recognize the incremental costs of obtaining a contract as an expense when incurred if the amortization period of the asset that the entity otherwise would have recognized is one year or less.

If an entity elects the practical expedient to expense incremental costs of obtaining a contract when incurred because the amortization period of the asset would have been one year or less, the entity is also required, under ASC 606-10-50-22, to disclose such election (see Chapter 15 on disclosure requirements). In addition, the practical expedient should be applied consistently to contracts with similar characteristics and in similar circumstances.

13.2.3.1 Whether the Practical Expedient Must Be Applied to All Contracts

The practical expedient in ASC 340-40-25-4 to expense contract acquisition costs that would be amortized over a period of less than one year needs to be applied consistently to contracts with similar characteristics and in similar circumstances in accordance with ASC 606-10-10-3. Therefore, if an entity has contracts with dissimilar characteristics or dissimilar circumstances, it can choose for each class of contract whether to apply the expedient.

The identification of contracts with similar characteristics and the evaluation of similar circumstances should be performed as an entity-wide assessment. An entity with multiple subsidiaries or business units that operate in multiple jurisdictions might determine that different subsidiaries or business units have contracts with dissimilar characteristics or dissimilar circumstances.

13.2.3.2 Whether the Practical Expedient May Be Applied Selectively on a Contract-by-Contract or Cost-by-Cost Basis

An entity is required to apply the practical expedient in ASC 340-40-25-4 consistently to contracts with similar characteristics and in similar circumstances in accordance with ASC 606-10-10-3. Therefore, if an entity has contracts with dissimilar characteristics or dissimilar circumstances, it can choose for each class of contract whether to apply the expedient, but it is not permitted to apply the practical expedient selectively on a contract-by-contract basis.

Further, an entity is not permitted to apply the practical expedient in ASC 340-40-25-4 to some costs attributable to performance obligations in a contract but not others. The incremental costs of obtaining a contract that are required to be capitalized in accordance with ASC 340-40-25-1 are related to the contract as a whole; the capitalized costs of obtaining a contract form a single asset even if the contract contains more than one performance obligation. Therefore, if the practical expedient in ASC 340-40-25-4 is applied, it should be applied to the contract as a whole. The practical expedient is available only if the amortization period of the entire asset that the entity otherwise would have recognized is one year or less.

13.2.3.3 Practical Expedient Unavailable When the Amortization Period Is Greater Than One Year

The example below illustrates a situation in which the practical expedient in ASC 340-40-25-4 would not be available.

Example 13-7

Entity B enters into a contract with a customer to provide the following:

Product X delivered at a point in time.
Maintenance of Product X for one year.
An extended warranty on Product X that covers years 2 and 3 (Product X comes with a one-year statutory warranty).

Each of the elements is determined to be a separate performance obligation.

A sales commission of $200 is earned by the salesperson. This represents $120 for the sale of Product X (payable irrespective of whether the customer purchases the maintenance or extended warranty) and an additional $40 each for the sale of the maintenance contract and the sale of the extended warranty ($80 commission for the sale of both).

The commission is determined to meet the definition of an incremental cost of obtaining the contract in ASC 340-40-25-2 and is therefore capitalized in accordance with ASC 340-40-25-1.

In this fact pattern, the entity cannot elect the practical expedient in ASC 340-40-25-4 to expense costs as incurred because the amortization period of the asset that the entity would recognize is more than one year (i.e., the extended warranty performance obligation included in the contract is for years 2 and 3). The entity may, however, determine that it is appropriate to attribute the asset created by the commission to the individual performance obligations and record amortization of the asset in an amount that corresponds to the revenue recognized as each good or service is transferred to the customer (see Section 13.4.1.1).

13.2.3.4 Amortization Periods Slightly Greater Than One Year

As previously noted, an entity is precluded from using the practical expedient in ASC 340-40-25-4 if the amortization period of the asset that the entity otherwise would have recognized is greater than one year. This restriction applies even if the amortization period is only slightly greater than one year.

Example 13-8

Entity A enters into a noncancelable contract with a customer to provide marketing services for 13 months. A commission of $100 is earned by the salesperson in connection with A’s entering into the contract with the customer. The commission is determined to meet the definition of an incremental cost of obtaining the contract in ASC 340-30-25-2 and is therefore capitalized in accordance with ASC 340-40-25-1. Entity A concludes that the asset is related to the entire contract to provide 13 months of marketing services.

In this fact pattern, the entity cannot elect the practical expedient in ASC 340-40-25-4 to expense costs as incurred since the amortization period of the asset that the entity would otherwise recognize is more than one year (i.e., the 13 months in which marketing services are being performed).

13.2.4 Using the Portfolio Approach When Accounting for Contract Costs

The guidance in ASC 340-40 was developed contemporaneously with that in ASC 606. ASC 340-40-05-1 expressly indicates that ASC 340-40 is aligned with ASC 606, stating that “[t]his Subtopic provides accounting guidance for the following costs related to a contract with a customer within the scope of Topic 606 on revenue from contracts with customers.”

ASC 606 is applied at the individual contract level (or to a combination of contracts accounted for under ASC 606-10-25-9). In addition, ASC 606-10-10-4 allows an entity to apply, as a practical expedient, the revenue recognition guidance to a portfolio of contracts rather than an individual contract. The practical expedient can only be used “if the entity reasonably expects that the effects on the financial statements of applying [the revenue recognition guidance] to the portfolio would not differ materially from applying [the revenue recognition guidance] to the individual contracts (or performance obligations) within that portfolio.” In addition, ASC 606-10-10-3 states that an “entity shall apply this guidance, including the use of any practical expedients, consistently to contracts with similar characteristics and in similar circumstances.”

If an entity reasonably expects that contract costs recorded under a portfolio approach would not differ materially from contract costs that would be recorded individually, it may apply a portfolio approach to account for the costs. The entity would use judgment in determining the characteristics of the portfolio in a manner similar to its assessment of whether a portfolio satisfies the requirements in ASC 606-10-10-4.

In applying the portfolio approach, an entity should consider paragraph BC69 of ASU 2014-09, which states, in part, that the FASB and IASB “did not intend for an entity to quantitatively evaluate each outcome and, instead, the entity should be able to take a reasonable approach to determine the portfolios that would be appropriate for its types of contracts.” In determining the characteristics and composition of the portfolio, an entity should consider the nature and timing of costs incurred and the pattern of transferring control of the related good or service to the customer (e.g., amortization of the capitalized costs).

13.2.5 Determining When to Recognize and How to Measure Incremental Costs

Arrangements for the payment of some incremental costs of obtaining a contract may be complex. For example, payment of a sales commission may be (1) contingent on a future event, (2) subject to clawback, or (3) based on achieving cumulative targets.

The revenue standard does not address the issue of when to initially recognize the incremental costs of obtaining a contract. Rather, ASC 340-40 only addresses which costs to capitalize and subsequent recognition of amortization or impairment expense. Therefore, other Codification topics (e.g., ASC 275, ASC 710, ASC 712, ASC 715, and ASC 718) specify when a liability for costs should be recognized and how that liability should be measured.

If an entity concludes that a liability for incremental costs of obtaining a contract should be recognized under the relevant Codification topic, the guidance in ASC 340-40-25-1 should be applied to determine whether those recognized costs should be capitalized as an asset or recognized immediately as an expense.

Confidential and Proprietary — for Use Solely by Authorized Personnel

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