13.4 Amortization and Impairment of Contract Costs

13.4.1 Amortization

ASC 340-40

35-1 An asset recognized in accordance with paragraph 340-40-25-1 or 340-40-25-5 shall be amortized on a systematic basis that is consistent with the transfer to the customer of the goods or services to which the asset relates. The asset may relate to goods or services to be transferred under a specific anticipated contract (as described in paragraph 340-40-25-5(a)).

35-2 An entity shall update the amortization to reflect a significant change in the entity’s expected timing of transfer to the customer of the goods or services to which the asset relates. Such a change shall be accounted for as a change in accounting estimate in accordance with Subtopic 250-10 on accounting changes and error corrections.

ASC 340-40 does not provide specific guidance on the method an entity should use to amortize contract costs recognized as assets. Rather, ASC 340-40-35-1 requires an entity to amortize such costs “on a systematic basis that is consistent with the transfer to the customer of the goods or services to which the asset relates.” Entities will therefore have to determine an appropriate method for amortizing costs capitalized in accordance with ASC 340-40-25-1 or ASC 340-40-25-5.

Amortization of capitalized costs on a “systematic basis” should take into account the expected timing of transfer of the goods and services related to the asset, which typically corresponds to the period and pattern in which revenue will be recognized in the financial statements. The pattern in which the related revenue is recognized could be significantly front-loaded, back-loaded, or seasonal, and costs should be amortized accordingly.

To determine the pattern of transfer, entities may need to analyze the specific terms of each arrangement. In determining the appropriate amortization method, they should consider all relevant factors, including (1) their experience with, and ability to reasonably estimate, the pattern of transfer and (2) the timing of the transfer of control of the goods or services to the customer. In some situations, more than one amortization method may be acceptable if it reasonably approximates the expected period and pattern of transfer of goods and services. However, certain amortization methods may be unacceptable if they are not expected to reflect the period and pattern of such transfer. When entities select a method, they should apply it consistently to similar contracts. If there is no evidence to suggest that a specific pattern of transfer can be expected, a straight-line amortization method may be appropriate.

If the pattern in which the contractual goods or services are transferred over the contract term varies significantly each period, it may be appropriate to use an amortization model that more closely aligns with the transfer pattern’s variations. For example, amortization could be allocated to the periods on the basis of the proportion of the total goods or services that are transferred each period. If the cost is related to goods or services that are transferred at a point in time, the amortized cost would be recognized at the same point in time.

When the contractual goods or services are transferred over a period of uncertain duration, entities should consider whether the relationship with the customer is expected to extend beyond the initial term of a “specific anticipated contract” (as referred to in ASC 340-40-35-1 and described in ASC 340-40-25-5(a)). For example, if an entity enters into a four-year contract with a customer but the customer is expected to renew that contract for two years, the appropriate amortization period may be six years (i.e., the expected duration of the period in which the customer will purchase the related goods or services, which could be the expected life of the customer relationship).

When an entity’s customer has been granted a material right to acquire future goods or services and revenue related to the material right is being deferred, it would typically be reasonable for the entity to consider the amount allocated to that right when determining the amortization method for the costs that are capitalized in accordance with ASC 340-40-25-1 or ASC 340-40-25-5.

13.4.1.1 Allocation Among Performance Obligations

When an asset is recognized for the incremental costs of obtaining a contract, ASC 340-40-35-1 requires that asset to be amortized in a manner that is “consistent with the transfer to the customer of the goods or services to which the asset relates” (emphasis added). When the pattern of transfer differs for separate performance obligations in a contract, it may be appropriate to allocate the costs among the performance obligations and to amortize the capitalized costs accordingly. For example, the costs could be allocated on the basis of the stand-alone selling prices of the performance obligations.

The FASB staff has noted that an entity could satisfy the requirement in ASC 340-40-35-1 in accordance with either of the following two views:3

(a) View A — Allocate the asset to the individual performance obligations on a relative basis (in proportion to the transaction price allocated to each performance obligation) and amortize the respective portion of the asset based on the pattern of performance for the underlying performance obligation . . . .

(b) View B — Amortize the single asset using one measure of performance considering all of the performance obligations in the contract. Use a measure that best reflects the “use” of the asset as the goods and services are transferred. Note that this approach may result in a similar pattern of amortization as View A, but without any specific allocation of the contract cost asset to individual performance obligations.

Note that as discussed in Section 13.2.3.3, an entity is not permitted to apply the practical expedient in ASC 340-40-25-4 (recognizing the “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”) to some performance obligations in a contract but not others. Therefore, when the costs of obtaining a contract are allocated to different performance obligations so that they are amortized over different periods, the practical expedient in ASC 340-40-25-4 can only be applied if all of the amortization periods are one year or less.

The above issue is addressed in Implementation Q&A 75 (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.

The example below illustrates an allocation of the costs of obtaining a contract among different performance obligations.

Example 13-16

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.

As discussed above, incremental costs of obtaining a contract that are capitalized in accordance with ASC 340-40-25-1 can be allocated to specific performance obligations for amortization purposes. Therefore, it would be acceptable in the circumstances under consideration to attribute the $200 commission asset in the following manner:

$120 to Product X — To be expensed upon delivery of Product X to the customer.
$40 to the maintenance contract — To be expensed over the one-year period of maintenance.
$40 to the extended warranty — To be expensed over the two-year period of the warranty (i.e., years 2 and 3).

The asset will therefore be amortized as follows:

Note that in this fact pattern, the entity cannot apply the practical expedient in ASC 340-40-25-4 to expense the sales commission when incurred because the total amortization period for the asset exceeds one year (see Section 13.2.3.3). Neither can the expedient be applied specifically to the commission allocated to the maintenance contract (notwithstanding that it is amortized over a period of one year) because if the practical expedient is applied, it must be applied to the contract as a whole (see Section 13.2.3.2).

13.4.1.2 Determining the Amortization Period of an Asset Recognized for the Incremental Costs of Obtaining a Contract With a Customer

Stakeholders have raised questions about determining the amortization period of an asset recognized for the incurred incremental costs of obtaining a contract with a customer, including how to determine whether a commission paid on renewal is commensurate with an initial commission and under what circumstances it would be appropriate to amortize the asset over the expected customer life. The FASB staff has noted that the amortization guidance in ASC 340-40 is conceptually consistent with that on estimating the useful lives of long-lived assets. Since entities already use judgment to estimate useful lives of long-lived assets, the staff believes that entities would also do so in determining amortization periods for assets related to incremental costs of obtaining a contract.

An entity should use judgment in determining the contract(s) to which a commission is related. The staff has noted that if an entity pays a commission on the basis of only the initial contract without an expectation that the contract will be renewed (given the entity’s past experience or other relevant information), amortizing the asset over the initial contract term would be an appropriate application of the revenue standard. However, if the entity’s past experience indicates that a contract renewal is likely, the amortization period could be longer than the initial contract term if the asset is related to goods or services to be provided during the contract renewal term.

When estimating the amortization period of an asset arising from incremental costs of obtaining a contract, entities should (1) identify the contract(s) to which the cost (i.e., commission) is related, (2) determine whether the commission on a renewal contract is commensurate with the commission on the initial contract, and (3) evaluate the facts and circumstances to determine an appropriate amortization period that would extend beyond the contract period if there are anticipated renewals associated with the costs of obtaining the contract.

The FASB staff has confirmed that the amortization period of an asset recognized for the incremental incurred costs of obtaining a contract might be, but should not be presumed to be, the entire customer life. The staff has suggested that facts and circumstances may clearly indicate that amortizing the asset over the average customer term is inconsistent with the amortization guidance in ASC 340-40-35-1. An entity should use judgment in assessing the goods or services to which the asset is related.

In estimating the amortization period for an asset recognized in accordance with ASC 340-40-25-1 (“customer acquisition asset”), an entity will need to use judgment to identify “the goods or services to which the asset relates.” The estimated amortization period could range from the initial contract term on the low end to the average customer life on the high end depending on the specific facts and circumstances. When determining the life of the customer acquisition asset, the entity will need to make judgments similar to those it makes when determining the amortization or depreciation period for other long-lived assets.

An entity should first identify the contract(s) related to the customer acquisition asset (e.g., commission payment). That is, an entity will need to consider whether the asset is related only to the initial contract with the customer or also to specific anticipated contracts (e.g., renewals) with the customer. For example, if a commission is paid on contract renewals and the commission is commensurate with the initial commission paid, the customer acquisition asset originally recorded may be related only to the initial contract.

However, if an entity’s past experience indicates that a contract renewal is likely, the amortization period could be longer than the initial contract term if the asset is related to goods or services to be provided under a contract renewal. An entity will need to use judgment to determine whether the asset is related to goods or services to be provided under the contract renewal term. Amortizing an asset over a period longer than the initial contract period would not be appropriate when the entity pays a commission on a contract renewal that is commensurate with the commission paid on the initial contract.

If no commissions are incurred in connection with a contract renewal, or if the commission paid is not commensurate with the initial commission, an entity will need to use judgment when determining whether the customer acquisition asset is related to (1) all future contracts with the customer (i.e., the customer life) or (2) one or more, but not all, future contracts with the customer. The revenue standard does not require an entity to amortize a customer acquisition asset over the expected customer life. Rather, the asset should “be amortized on a systematic basis that is consistent with the transfer to the customer of the goods or service to which the asset relates.” An entity will need to determine the appropriate amortization period on the basis of all relevant facts and circumstances.

Since the capitalized asset is similar to an intangible asset, an entity might consider the guidance in ASC 350-30 on determining the useful life of intangible assets. Specifically, ASC 350-30-35-3 states, in part:

The estimate of the useful life of an intangible asset to an entity shall be based on an analysis of all pertinent factors, in particular, all of the following factors with no one factor being more presumptive than the other: . . .

f. The level of maintenance expenditures required to obtain the expected future cash flows from the asset (for example, a material level of required maintenance in relation to the carrying amount of the asset may suggest a very limited useful life). As in determining the useful life of depreciable tangible assets, regular maintenance may be assumed but enhancements may not.

Entities may perform various activities geared toward maintaining customer relationships. In some instances, there may be significant barriers to a customer’s changing service providers or suppliers so that once a contractual relationship is formed between an entity and a customer, little effort may be needed for the entity to retain the customer. However, in other circumstances, entities may operate in a highly competitive environment in which there are only limited barriers, if any, to a customer’s switching service providers or suppliers. In these circumstances, entities may need to make additional investments or incur other costs to maintain customer relationships (e.g., invest in innovative products or services, or provide customer incentives). The additional investments may be akin to “maintenance expenditures” that may affect the useful life of a customer acquisition asset.

While an entity will need to use judgment to determine the amortization period of the customer acquisition asset, the entity might consider the following factors:

Incremental costs of obtaining a sale (e.g., commissions) relative to ongoing contract value — A small commission relative to the value of the contract could suggest that the customer acquisition asset has limited value and that the asset life is relatively short. In contrast, a higher commission payment relative to the contract value (1) could suggest that the entity believes the asset to be of greater value or (2) may be related to anticipated contracts with the customer.
Degree of difficulty in switching service providers or suppliers — If it is difficult for a customer to switch service providers or suppliers, the customer acquisition asset may have a longer life. Accordingly, the entity may expect that the efforts it performed to acquire the customer will provide it with value over a longer period (i.e., over some or all contract renewals). In contrast, if there are only limited barriers to a customer’s switching service providers or suppliers (and there are other service providers or suppliers available to the customer), the customer acquisition asset may have a shorter life.
Extent to which the product or service changes over the customer life — Significant changes in the underlying product or service over the customer life may suggest that the life of the customer acquisition asset is shorter than the customer life. That is, the asset may be related to some, but not all, anticipated contracts with the customer. For example, if a customer’s decision about whether to renew a contract is influenced by enhancements made to products or services, the activities required to initially obtain the customer may not be related to all anticipated contract renewals with the customer. In contrast, if the same service or product is provided in each renewal period, the customer acquisition asset may be attributed to all anticipated contract renewals.
Other customer maintenance activities — If the entity incurs significant costs (relative to the initial incremental cost incurred) to maintain a customer relationship, the useful life of the customer acquisition asset could be short. However, if only limited costs are required to maintain a customer relationship, the useful life of the customer acquisition asset could extend to all anticipated contracts with the customer (i.e., the customer life). Fulfillment costs would not be considered customer maintenance costs. Only costs that are incremental to transferring the specified goods or services to the customer should be evaluated as maintenance costs.

The above factors are not all-inclusive, and none of them are determinative. Accordingly, an entity should consider all relevant facts and circumstances when determining the amortization period for customer acquisition assets. In addition, an entity should adequately disclose the method it uses to determine the amortization for each reporting period in accordance with ASC 340-40-50-2(b).

The above issue is addressed in Implementation Q&As 71 and 79 (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.

13.4.1.2.1 Specific Anticipated Contract Not Limited to Contract Renewals

The reference to a “specific anticipated contract” in ASC 340-40-35-1 is not limited to contract renewals. Although the guidance in ASC 340-40-35-1 will often be relevant in the context of contract renewals (see Section 13.4.1.2), it is not limited to contract renewals for purposes of determining the amortization period for capitalized incremental costs incurred to obtain a contract.

For example, an entity may incur incremental costs of obtaining a contract to deliver one part of an overall project for a customer. The entity may have been informed that if it successfully fulfills its performance obligations under the initial contract, the customer will award the entity an additional contract to deliver other parts of the project. If the entity will not incur any further incremental costs to obtain the additional contract, it may be appropriate to regard the additional contract as a “specific anticipated contract” under ASC 340-40-35-1.

13.4.1.2.2 Evaluating Whether Commissions Paid on a Contract Renewal Are Commensurate With Commissions Paid on the Initial Contract

Paragraph BC309 of ASU 2014-09 states that amortization of an asset over a period longer than the initial contract period would not be appropriate when a commission paid on a contract renewal is commensurate with the commission paid on the initial contract.

The FASB staff has confirmed that when commissions are paid on contract renewals, an entity should evaluate whether the commission on renewal is commensurate with the initial commission by considering the amount of the commissions relative to the contracts’ value. It has specifically noted that “assessing whether a renewal commission is commensurate with an initial commission solely on the basis of the level of effort to obtain the contract would not be consistent with the guidance in Subtopic 340-40.”4

In addition, the FASB staff has clarified that it holds the following views5 irrespective of the relative level of effort involved with obtaining the original contract and the renewal contract:

“[I]n general, it would be reasonable for an entity to conclude that a renewal commission is ‘commensurate with’ an initial commission if the two commissions are reasonably proportional to the respective contract value (for example, 5% of the contract value is paid for both the initial and the renewal contract).”
“Similarly, [it] would be reasonable for an entity to conclude that a renewal commission is not ‘commensurate with’ an initial commission if it is disproportionate to the initial commission (for example, 2% renewal commission as compared to a 6% initial contract commission).”

The above issue is addressed in Implementation Q&A 72 (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.

13.4.1.2.3 Determining the Appropriate Amortization Period of Commissions When a Commission Paid Upon Renewal Is Not Commensurate With the Initial Commission

Stakeholders have also raised questions about the appropriate amortization period for a commission paid to an employee for obtaining an initial contract that has a high likelihood of renewal. That is, should the commission be amortized over the initial contract term, or should the amortization period include the expected renewal period? The amortization period will depend on many factors, including whether a commission is paid on contract renewals and, if so, whether the commission paid is commensurate with the initial commission.

Example 13-17

Entity X enters into a two-year contract with a customer. On signing the initial contract, X pays its salesperson $200 for obtaining the contract. An additional commission of $120 is paid each time the customer renews the contract for another two years. Assume that the $120 renewal commission is not commensurate with the $200 initial commission, which means that some of the commission paid for the initial contract should be attributed to the contract renewal as well. On the basis of historical experience, 98 percent of X’s customers are expected to renew their contract for at least two more years (i.e., the contract renewal is a specific anticipated contract), and the average customer life is four years.

In this example, we believe that there are at least two acceptable approaches to amortizing the initial $200 commission and the $120 renewal commission:

Approach 1 — Amortize the initial commission amount of $200 over the contract period that includes the anticipated renewal (i.e., four years). When the contract is renewed, the additional $120 commission would be combined with the remaining asset and amortized over the remaining two-year period, as shown in the following table:
Approach 2 — Bifurcate the initial commission into two parts: (1) $120, the amount that is commensurate with the renewal commission and that pertains to obtaining a two-year contract, and (2) $80, the amount that is considered to be paid for obtaining the initial contract plus the anticipated renewal (i.e., the customer relationship). The $120 would then be amortized over the initial two-year contract term, and the $80 would be amortized over the entire four-year period, as shown in the following table:

As noted in the example above, we believe that there are multiple acceptable approaches to amortizing costs of obtaining contract assets when commissions paid upon renewal are not commensurate with the initial commission paid. The example below illustrates how the alternatives may be applied when a good or service is transferred at the inception of an arrangement and another good or service is transferred over time.

Example 13-18

Software Company

Company A enters into a software arrangement with a customer in exchange for consideration of $1,300. Under the arrangement, A provides a software license ($1,000) and three years of postcontract customer support (PCS) ($100 per year). In addition, the arrangement includes two years of optional PCS renewals for which the customer is able to renew at $100 per year. At contract inception, A expects that the customer will renew the PCS for both years. The corresponding commission rates for the software license and PCS (including renewals) are as follows:

For purposes of this example, assume that revenue is recognized as follows:

As illustrated above, the commission paid upon PCS renewal in years 4 and 5 is not commensurate with the commission paid on PCS in the initial contract; therefore, the initial commission is related to both the original contract and the renewal periods. We believe that in this example, there are at least two acceptable approaches to amortizing the initial $120 commission and the $2 renewal commission:

Approach 1 — Amortize the initial commission amount of $120 proportionately over the contract period that includes the anticipated renewals (e.g., five years) by multiplying the annual revenue amount in each year by Percentage 1. The incremental commission from years 4 and 5 would be amortized over the remaining two-year period, as shown in the following table:
Approach 2 — Amortize the total expected commission amount of $122 over the contract period that includes the anticipated renewals (e.g., five years) by multiplying the annual revenue amount by Percentage 2, as shown in the following table:

The above issue is addressed in Implementation Q&A 71 (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.

13.4.1.3 Accounting for Unamortized Contract Costs Upon Modification

ASC 606-10-25-13(a) provides that when specified criteria are met, an entity should account for a contract modification “as if it were a termination of the existing contract, and the creation of a new contract.” Although the contract modification is accounted for as if it were a termination of the existing contract and the creation of a new contract, the original contract was not in fact terminated. Therefore, any unamortized contract costs that existed immediately before the contract modification should not be written off unless those costs are no longer related to the remaining goods or services. Rather, those unamortized contract costs should be carried forward into the new contract and amortized on a systematic and rational basis that is consistent with the transfer of goods or services related to the asset.

An entity will need to use judgment when determining which remaining goods or services to be transferred under the modified contract are related to the asset (see Section 13.4.1.2). Further, the entity should consider whether the asset is impaired by applying the guidance in ASC 340-40-35-3 through 35-5 (see Section 13.4.2).

13.4.2 Impairment

ASC 340-40

35-3 An entity shall recognize an impairment loss in profit or loss to the extent that the carrying amount of an asset recognized in accordance with paragraph 340-40-25-1 or 340-40-25-5 exceeds:

The amount of consideration that the entity expects to receive in the future and that the entity has received but has not recognized as revenue, in exchange for the goods or services to which the asset relates (“the consideration”), less
The costs that relate directly to providing those goods or services and that have not been recognized as expenses (see paragraphs 340-40-25-2 and 340-40-25-7).

35-4 For the purposes of applying paragraph 340-40-35-3 to determine the consideration, an entity shall use the principles for determining the transaction price (except for the guidance in paragraphs 606-10-32-11 through 32-13 on constraining estimates of variable consideration) and adjust that amount to reflect the effects of the customer’s credit risk. When determining the consideration for the purposes of paragraph 340-40-35-3, an entity also shall consider expected contract renewals and extensions (with the same customer).

35-5 Before an entity recognizes an impairment loss for an asset recognized in accordance with paragraph 340-40-25-1 or 340-40-25-5, the entity shall recognize any impairment loss for assets related to the contract that are recognized in accordance with another Topic other than Topic 340 on other assets and deferred costs, Topic 350 on goodwill and other intangible assets, or Topic 360 on property, plant, and equipment (for example, Topic 330 on inventory and Subtopic 985-20 on costs of software to be sold, leased, or otherwise marketed). After applying the impairment test in paragraph 340-40-35-3, an entity shall include the resulting carrying amount of the asset recognized in accordance with paragraph 340-40-25-1 or 340-40-25-5 in the carrying amount of the asset group or reporting unit to which it belongs for the purpose of applying the guidance in Topics 360 and 350.

35-6 An entity shall not recognize a reversal of an impairment loss previously recognized.

The objective of impairment is to determine whether the carrying amount of the contract acquisition and fulfillment costs asset is recoverable. This is consistent with other impairment methods under U.S. GAAP and IFRS Accounting Standards that include an assessment of customer credit risk and expectations of whether variable consideration will be received.

Further, the FASB decided that it would not be appropriate to reverse an impairment charge when the reasons for impairment are no longer present. In contrast, the IASB decided to allow a reversal of the impairment charge in these circumstances. The boards decided to diverge on this matter to maintain consistency with their respective existing impairment models for other types of assets.

To test a contract cost asset for impairment, an entity must consider the total period over which it expects to receive an economic benefit from the asset. Accordingly, to estimate the amount of remaining consideration that it expects to receive, the entity would also need to consider goods or services under a specific anticipated contract (e.g., a contract renewal). However, the impairment guidance as originally issued in ASU 2014-09 appeared to contradict itself because it also indicated that an entity should apply the principles used to determine the transaction price when calculating the “amount of consideration that [the] entity expects to receive.”6 The determination of the transaction price would exclude renewals.7

At the July 2014 TRG meeting, TRG members generally agreed that when testing a cost asset for impairment, an entity would consider the economic benefits from anticipated contract extensions or renewals if the asset is related to the goods and services that would be transferred during those extension or renewal periods.

As a result of the TRG discussions noted above, the FASB issued ASU 2016-20, which includes certain technical corrections that amend ASC 340-40 to clarify that for impairment testing, an entity should:

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

Footnotes

Quoted text from Implementation Q&A 75.

Quoted from Implementation Q&A 72.

See footnote 4.

ASC 340-40-35-4 (paragraph 102 of IFRS 15).

ASC 606-10-32-4 (paragraph 49 of IFRS 15) states, “For the purpose of determining the transaction price, an entity shall assume that the goods or services will be transferred to the customer as promised in accordance with the existing contract and that the contract will not be cancelled, renewed, or modified.”

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