Chapter 4 — Step 1: Identify the Contract

4.5 Reassessing the Criteria for Identifying a Contract

An entity is required to evaluate the criteria in ASC 606-10-25-1 at contract inception to determine whether a valid and genuine transaction exists for accounting purposes. Once an entity concludes that the criteria are met (i.e., that a valid contract exists), it is not required to reassess the criteria unless there has been a significant change in facts and circumstances (i.e., changes that might call into question the existence of a contract rather than minor changes that might reasonably be expected over the contract term, particularly for long-term contracts). A reassessment may be required, for example, if an entity determines that its remaining contractual rights and obligations are no longer enforceable or if other changes suggest that a valid and genuine transaction no longer exists.

If an entity is required to reassess its contract because of a significant change in facts and circumstances, the criteria in ASC 606-10-25-1 would only be evaluated in the context of the remaining goods or services that have yet to be provided. The reassessment would not affect any assets or revenue that has been recognized from satisfied performance obligations. However, assets would need to be evaluated for impairment under other applicable guidance, such as ASC 326.

ASC 606-10

25-5 If a contract with a customer meets the criteria in paragraph 606-10-25-1 at contract inception, an entity shall not reassess those criteria unless there is an indication of a significant change in facts and circumstances. For example, if a customer’s ability to pay the consideration deteriorates significantly, an entity would reassess whether it is probable that the entity will collect the consideration to which the entity will be entitled in exchange for the remaining goods or services that will be transferred to the customer (see paragraphs 606-10- 55-3A through 55-3C).

25-6 If a contract with a customer does not meet the criteria in paragraph 606-10-25-1, an entity shall continue to assess the contract to determine whether the criteria in paragraph 606-10-25-1 are subsequently met.

There may be situations in which an entity concludes at contract inception that the criterion in ASC 606-10-25-1(e) is met but subsequent changes in circumstances lead the entity to question whether it will collect consideration from the customer. In general, once an entity makes a determination that a contract exists in accordance with ASC 606-10-25-1, the determination is not reevaluated. However, in accordance with ASC 606-10-25-5, an entity should reassess the criteria in ASC 606-10-25-1 when “there is an indication of a significant change in facts and circumstances.” As a result, when concerns arise regarding the collectibility of consideration, an entity will need to use judgment to determine whether those concerns arise from a significant change in facts and circumstances in the context of ASC 606-10-25-5.

Example 4 in ASC 606-10-55-106 through 55-109, which is reproduced below, illustrates when a change in the customer’s financial condition is so significant that a reassessment of the criteria in ASC 606-10-25-1 is required. As a result of the reassessment, the entity in the example determines that the collectibility criterion is not met and that the contract therefore fails step 1. Accordingly, the entity is precluded from recognizing additional revenue under the contract until the criteria in ASC 606-10-25-7 are met or collectibility becomes probable. The entity also assesses any related contract assets or accounts receivable for impairment.

ASC 606-10

Example 4 — Reassessing the Criteria for Identifying a Contract

55-106 An entity licenses a patent to a customer in exchange for a usage-based royalty. At contract inception, the contract meets all the criteria in paragraph 606-10-25-1, and the entity accounts for the contract with the customer in accordance with the guidance in this Topic. The entity recognizes revenue when the customer’s subsequent usage occurs in accordance with paragraph 606-10-55-65.

55-107 Throughout the first year of the contract, the customer provides quarterly reports of usage and pays within the agreed-upon period.

55-108 During the second year of the contract, the customer continues to use the entity’s patent, but the customer’s financial condition declines. The customer’s current access to credit and available cash on hand are limited. The entity continues to recognize revenue on the basis of the customer’s usage throughout the second year. The customer pays the first quarter’s royalties but makes nominal payments for the usage of the patent in quarters 2–4. The entity accounts for any credit losses on the existing receivable in accordance with Subtopic 326-20 on financial instruments measured at amortized cost.

55-109 During the third year of the contract, the customer continues to use the entity’s patent. However, the entity learns that the customer has lost access to credit and its major customers and thus the customer’s ability to pay significantly deteriorates. The entity therefore concludes that it is unlikely that the customer will be able to make any further royalty payments for ongoing usage of the entity’s patent. As a result of this significant change in facts and circumstances, in accordance with paragraph 606-10-25-5, the entity reassesses the criteria in paragraph 606-10-25-1 and determines that they are not met because it is no longer probable that the entity will collect the consideration to which it will be entitled. Accordingly, the entity does not recognize any further revenue associated with the customer’s future usage of its patent. The entity accounts for additional credit losses on the existing receivable in accordance with Subtopic 326-20.

Connecting the Dots

Stakeholders have questioned how to evaluate the reassessment criteria in ASC 606-10-25-5 to determine when to reassess whether a contract continues to meet the collectibility threshold. The assessment of whether a significant change in facts and circumstances occurred will be situation-specific (e.g., a significant change due to a bankruptcy) and will often be a matter of judgment.

The above issue is addressed in Implementation Q&A 10 (compiled from previously issued TRG Agenda Papers 13 and 25). For additional information and Deloitte’s summary of issues discussed in the Implementation Q&As, see Appendix C.

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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.