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 310 (or ASC
326, once adopted9).
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 impairment of the
existing receivable in accordance with Topic 310 on
receivables.
Pending Content (Transition Guidance: ASC
326-10-65-1)
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 any impairment of the
existing receivable in accordance with Topic 310 on
receivables.
Pending Content (Transition Guidance: ASC
326-10-65-1)
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.
Footnotes
9
See footnote 5.