Chapter 4 — Step 1: Identify the Contract

4.6 Consideration Received When the Criteria for Identifying a Contract Are Not Met

If a contract does not meet the criteria in ASC 606-10-25-1 at contract inception, no revenue can be recognized until either the contract existence criteria are met or other conditions are satisfied. That is, any consideration received from a customer, including nonrefundable consideration, is precluded from being recognized as revenue until certain events have occurred.

ASC 606-10

25-7 When a contract with a customer does not meet the criteria in paragraph 606-10-25-1 and an entity receives consideration from the customer, the entity shall recognize the consideration received as revenue only when one or more of the following events have occurred:

The entity has no remaining obligations to transfer goods or services to the customer, and all, or substantially all, of the consideration promised by the customer has been received by the entity and is nonrefundable.
The contract has been terminated, and the consideration received from the customer is nonrefundable.
The entity has transferred control of the goods or services to which the consideration that has been received relates, the entity has stopped transferring goods or services to the customer (if applicable) and has no obligation under the contract to transfer additional goods or services, and the consideration received from the customer is nonrefundable.

25-8 An entity shall recognize the consideration received from a customer as a liability until one of the events in paragraph 606-10-25-7 occurs or until the criteria in paragraph 606-10-25-1 are subsequently met (see paragraph 606-10-25-6). Depending on the facts and circumstances relating to the contract, the liability recognized represents the entity’s obligation to either transfer goods or services in the future or refund the consideration received. In either case, the liability shall be measured at the amount of consideration received from the customer.

Connecting the Dots

The contract existence criteria provide a framework for determining when a contract with a customer includes all of the elements required to apply the rest of the revenue recognition model. The model relies on a complete analysis of the rights and obligations under the contract. For an entity to recognize revenue in an amount that depicts the consideration to which it expects to be entitled in exchange for promised goods or services, the entity needs to be able to adequately determine both the promised goods or services and the consideration to which it expects to be entitled (along with meeting the other criteria). When any of the contract existence criteria are not met (including the collectibility threshold), the entity is unable to determine how to allocate consideration to promised goods or services under the contract because either the promised consideration or the promised goods or services are inadequately defined. Consequently, even if nonrefundable consideration is received from a customer and the entity has transferred some of the goods or services promised under the contract, if the contract existence criteria are not met and none of the events in ASC 606-10-25-7 have occurred, the entity is unable to conclude that the consideration received is related entirely to satisfied (or partially satisfied) performance obligations. Therefore, any such consideration received needs to be recorded as a liability until the entity determines that either the contract existence criteria are met or one of the events in ASC 606-10-25-7 has occurred.

4.6.1 Whether a Contract Can Be Deemed Terminated if Pursuit of Collection Continues

ASU 2014-09 did not include the criterion in ASC 606-10-25-7(c). In some cases, questions arose about whether the criterion in ASC 606-10-25-7(b) was met — specifically, whether a contract can be deemed to be terminated if goods or services were transferred to a customer and some nonrefundable consideration was received, but the customer paid less than the full transaction price and the entity continued to pursue collection of outstanding balances to which it was entitled. ASU 2016-12 added a third criterion, ASC 606-10-25-7(c),10 to enable an entity to recognize consideration received from a customer as revenue when the contract does not meet the criteria in ASC 606-10-25-1 if (1) the “entity has transferred control of the goods or services to which the consideration that has been received relates,” (2) “the entity has stopped transferring goods or services to the customer (if applicable) and has no obligation under the contract to transfer additional goods or services,” and (3) “the consideration received from the customer is nonrefundable.”

When the events described in ASC 606-10-25-7(c) occur, it will be evident that nonrefundable consideration received from a customer is entirely related to satisfied performance obligations (or satisfied portions of a performance obligation that is satisfied over time). That is, the customer will no longer have rights to obtain additional goods or services from the entity, and the entity has no further obligation (or intention) to transfer goods or services to the customer. In these circumstances, the contract can be accounted for as if it were terminated (i.e., revenue can be recognized for the nonrefundable consideration received) even if the entity continues to pursue collection of outstanding balances from the customer.

4.6.2 Whether a Receivable Can Be Recorded When a Contract Fails Step 1 Because Collectibility Is Not Probable

If an entity decides to transfer its promised goods or services before collecting consideration from its customer and the collection of such consideration is not probable, a question arises about whether the entity can recognize a receivable for the amount of consideration to which it is legally entitled.

ASC 606-10-45-4 states, in part, the following (pending content effective later than the effective date of ASC 606 {in braces}):

A receivable is an entity’s right to consideration that is unconditional. A right to consideration is unconditional if only the passage of time is required before payment of that consideration is due. . . . An entity shall account for a receivable in accordance with Topic 310 {and Subtopic 326-20}.

In general, an entity cannot record a receivable if it transfers a good or service to its customer but the accounting contract fails step 1 because collectibility of the expected consideration is not probable. While an entity may have a legal contract, if it cannot conclude that a contract exists from an accounting perspective, it cannot recognize revenue and typically would not recognize a receivable.

Example 1, Case A, in ASC 606-10-55-95 through 55-98 illustrates a situation in which an entity concludes that it does not have a contract with a customer because one of the criteria in ASC 606-10-25-1 is not met — specifically, collectibility of the expected consideration is not probable. In the revenue standard as originally issued, the example11 included the following text (subsequently deleted from ASC 606-10-55-98 by ASU 2016-12), which we still believe appropriately reflects the timing of recognizing receivables for contracts that have not yet met the criteria in step 1:

Because the criteria in paragraph 606-10-25-1 are not met, the entity applies paragraphs 606-10-25-7 through 25-8 to determine the accounting for the nonrefundable deposit of $50,000. The entity observes that none of the events described in paragraph 606-10-25-7 have occurred — that is, the entity has not received substantially all of the consideration and it has not terminated the contract. Consequently, in accordance with paragraph 606-10-25-8, the entity accounts for the nonrefundable $50,000 payment as a deposit liability. The entity continues to account for the initial deposit, as well as any future payments of principal and interest, as a deposit liability and does not derecognize the real estate asset. Also, the entity does not recognize a receivable until such time that the entity concludes that the criteria in paragraph 606-10-25-1 are met (that is, the entity is able to conclude that it is probable that the entity will collect the consideration) or one of the events in paragraph 606-10-25-7 has occurred. [Emphasis added]

ASU 2016-12 deleted the text above from ASC 606-10-55-98 to make the Codification example focus only on the evaluation of the collectibility threshold. We believe that the principle in the original example is still appropriate and that a receivable would generally not be recognized if goods or services are transferred to a customer but the contract fails step 1 because collectibility is not probable.

When an entity has a right to recover products from customers, it may be acceptable for the entity to record an asset (and corresponding adjustment to cost of sales) for its right to recover products from customers on settling the refund liability. For example, if the entity is unable to conclude that a contract has met all of the step 1 criteria because collectibility of the expected consideration is not probable, but the entity has already transferred inventory to the customer, the entity may record an asset for the right to the inventory if the legal contract stipulates that the entity has the right to take back the inventory in the event that the customer does not pay.

Footnotes

The IASB did not amend IFRS 15 to add this third criterion. For a summary of differences between U.S. GAAP and IFRS Accounting Standards on revenue-related topics, see Appendix A.

That is, what the revenue standard, as amended by ASU 2016-12, refers to as Case A of Example 1. Before ASU 2016-12 was issued, Example 1 had only one fact pattern.

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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.