14.6 Classification as Current or Noncurrent

Entity X enters into two noncancelable contracts with two different customers (“Contract A” and “Contract B”). Entity X promises to sell each customer (1) a subscription to a cloud-based service running diagnostics of the customer’s facility and (2) certain equipment. For purposes of this example, the cloud-based service subscription and each piece of equipment represent distinct performance obligations. Assume that there is no significant financing component.

The stand-alone selling price and the expected pattern and timing of satisfaction of each of the performance obligations are as follows:

The terms of each contract are described below. 

Entity X’s performance obligations and the payment terms under Contract A are as follows:

The total transaction price of $40,000 is allocated to the performance obligations on the basis of their relative stand-alone selling prices as follows:

The table below shows the transactions that have occurred as of March 31, 20X0, and the resulting impacts.

The contract asset and contract liabilities within a single contract must first be netted before bifurcation between current and noncurrent presentation on the balance sheet. Accordingly, X determines that it has a net contract liability balance of $33,000 as of March 31, 20X0. In addition, X has a remaining performance obligation of $34,000 ($33,000 for the cloud-based service and $1,000 for Equipment D). Entity X determines that it is appropriate to present a current liability ($12,000) and a noncurrent liability ($21,000). This is because X expects to deliver 12 months of the cloud-based service within the next 12 months, which would result in $12,000 of revenue recognition. The remaining deferred revenue balance is related to promised goods or services that will be transferred to the customer beyond 12 months and would therefore be classified as noncurrent.

The following journal entry illustrates how X accounts for Contract A as of March 31, 20X0:

Contract B 

Entity X’s performance obligations and the payment terms under Contract B are as follows:

• One-year subscription to the cloud-based service commencing on January 1, 20X0 — A payment of $12,000 is due on December 31, 20X0.
• Equipment C — A payment of $5,000 is due upon delivery on January 31, 20X0. 
• Equipment E — No payment is due upon delivery on September 30, 20X0.

The total transaction price of $17,000 is allocated to the performance obligations on the basis of their relative stand-alone selling prices as follows:

• $12,000 is allocated to the one-year subscription to the cloud-based service.
• $3,000 is allocated to Equipment C.
• $2,000 is allocated to Equipment E.

The table below shows the transactions that have occurred as of March 31, 20X0, and the resulting impacts.

There is a net contract asset of $1,000, which is the difference between the contract asset of $3,000 and the contract liability of $2,000 as of March 31, 20X0.

The contract asset and contract liabilities within a single contract must first be netted before bifurcation between current and noncurrent presentation on the balance sheet. ASC 606 does not prescribe how consideration received should be applied in a contract that includes multiple performance obligations. There is a difference between the $5,000 of consideration received and the $3,000 of revenue allocated to Equipment C. Since X has transferred 3 months of the cloud-based service to the customer, X has a $3,000 contract asset related to the cloud-based service (current because payment is expected to be received within 12 months). Note that as of March 31, 20X0, on the basis of the payment terms, X does not have a right to the $12,000 consideration that is unconditional (a receivable) until 12 months of the cloud-based service are transferred to the customer. Hence, when X recognizes revenue for the 3 months of cloud-based service delivered to date, it recognizes a contract asset rather than a receivable.

Some may consider the $2,000 additional consideration to be partial payment related to the cloud-based service subscription transferred to date, while others may argue that the $2,000 is a prepayment for Equipment E. In either case, the determination of the amount of the net contract asset (or net contract liability) would be the same. That is, X has either of the following:

• A $1,000 contract asset related to the 3-month subscription to date for which there is no unconditional right to payment.
• A net $1,000 contract asset (a $3,000 contract asset related to the cloud-based service less a $2,000 contract liability for Equipment E).

In this fact pattern, since it is expected that all performance obligations will be satisfied within one year of the reporting date (March 31, 20X0), the $1,000 contract asset would be classified as a current asset.

The following journal entry illustrates how X accounts for Contract B on March 31, 20X0:

As of March 31, 20X0, under the assumption that Contract A and Contract B were the only arrangements that X accounted for, X would report the consolidated contract asset and contract liability on its financial statements related to Contract A and Contract B as follows:

Entity P, an entity with an operating cycle of less than 12 months, expects to return proceeds related to refund liabilities (or similar liabilities) more than 12 months after the reporting date. However, the counterparty can demand a refund of amounts previously paid at any time.

Entity P should not classify the portion that it expects to repay more than 12 months after the reporting date as a noncurrent liability in a classified balance sheet. All amounts related to such liabilities should be recorded as a current liability because the counterparty can demand a refund at any time.