5.4 Defining the Nature of the Promise
5.4.1 In General
As previously discussed, performance obligations can vary greatly across industries, within industries,
and even within a company. An entity must assess its contracts with customers to determine what
performance obligations it needs to satisfy. Once it completes this task, the entity will have to determine
the appropriate pattern of satisfaction of the performance obligations (see Chapter 8 for discussion
of step 5). As noted in paragraph BC159 of ASU 2014-09, an entity does not have a “free choice” in
determining the appropriate method for measuring progress toward satisfaction of the performance
obligations; rather, the entity should use judgment to choose a measurement method that faithfully represents
the pattern of satisfaction of the performance obligation. To accomplish this, the entity should assess
the nature of the promises in its performance obligations (i.e., consider how and when it will satisfy its
performance obligations).
5.4.2 Impact of Exclusivity on the Identification of Performance Obligations
Certain contracts with customers may include conditions related
to exclusivity that restrict the entity’s ability to sell goods or services to
other customers or in certain geographies. The exclusivity may be limited in
time or may be indefinite.
For example, an entity may provide a customer with an exclusive
license of IP, thus preventing the entity from issuing licenses of that IP to
other customers. Alternatively, an entity may enter into an exclusive
distribution arrangement to provide goods or services to a customer in a
specific geographic area, thereby limiting the entity’s ability to sell goods or
services to other customers in that geographic area.
Generally, it is not appropriate to identify exclusivity as a
performance obligation in a contract with a customer.
In paragraph BC412(b) of ASU 2014-09, the FASB and IASB
discussed the effect of exclusivity clauses in the context of licenses of IP.
They acknowledged that many respondents to the boards’ 2010 exposure draft on
revenue “explained that a distinction based on exclusivity was inconsistent with
the control principle because exclusivity does not affect the determination of
the entity’s performance.” In addition, the boards noted that “exclusivity is
another restriction that represents an attribute . . . rather than the nature of
the underlying intellectual property or the entity’s promise in granting a
license.” As a result, exclusivity is not accounted for separately in a license
arrangement.
Although the discussion above was in the context of licenses of
IP, the comments made are equally valid in the context of other goods and
services. Accordingly, exclusivity would generally be seen as an attribute of
the goods or services supplied, as opposed to a separate promise in itself,
because exclusivity does not affect the nature of the entity’s performance to
provide the underlying goods or services.
5.4.3 Stand-Ready Obligations
Contracts promise specific goods and services, but sometimes they also promise
to deliver those goods and services over a specified period. ASC 606-10-25-18(e)
describes a service of “standing ready” to provide goods or services
(“stand-ready obligation”). The customer receives and consumes a benefit from a
stand-ready obligation — namely, the assurance that a service (e.g., snow
removal during the winter) is available to the customer when and if needed or
called upon. When an entity enters into a contract with a customer and agrees to
make itself available to provide goods and services to the customer over a
specified period, such a promise is generally viewed as a stand-ready
obligation. In this type of arrangement, (1) a customer may make requests of the
entity to deliver some or all of the goods and services at some point during the
period defined in the contract, or (2) the delivery of some or all of the goods
and services on a when-and-if-available basis may be in the control of the
entity.
The TRG discussed stand-ready obligations because of the
concerns and questions that stakeholders have raised. Stakeholders have
identified four broad types of promises or arrangements that may constitute
stand-ready obligations, including those for which the obligation to deliver
goods or services is:
-
Within the entity’s control, but for which additional development of the goods, services, or IP is required (“Type A”).
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Outside both the entity’s and the customer’s control (“Type B”).
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Solely within the customer’s control (“Type C”).
The fourth category identified is promises to make an entity’s
goods or services available to the customer continuously over the contractual
period — such as a health club membership, which is the only example of
measuring progress toward completion of a stand-ready obligation in the revenue
standard11 (“Type D”). A potential way to account for a Type D arrangement is for the
entity to record revenue ratably over the performance period on a straight-line
basis. Straight-line revenue recognition results because (1) the customer is
required to pay regardless of how frequently he or she uses the health club and
(2) the entity stands ready to make its goods or services available to the
customer on a constant basis over the contract period.
Because the revenue standard provides an example of Type D
arrangements but not others, questions have arisen regarding the identification
of other stand-ready obligations (i.e., Types A through C) and how to
appropriately measure progress toward completion of delivering the promised
goods or services. Specifically, views differ on (1) what constitutes the nature
of the promise in the aforementioned arrangements (e.g., whether it is the act
of standing ready or the actual delivery of the goods or services to the
customer) and (2) the methods used to measure progress toward the complete
satisfaction of a stand-ready obligation (e.g., a time-based, input, or output
method).
Entities will need to use judgment when evaluating arrangements
that have characteristics of Types A through C as described above. Sections 5.4.3.1 and 5.4.3.2 provide additional guidance to help
entities make the necessary judgments.
5.4.3.1 Assessing Whether a Promise Is a Stand-Ready Performance Obligation
Distinguishing a performance obligation to deliver goods or
services from a stand-ready obligation to deliver goods or services may be
complex and will require an entity to consider the arrangement’s relevant
facts and circumstances. However, an entity should begin by identifying the
nature of the promise in the contract. For example, the determination of
whether the promise is an obligation to provide one or more defined goods or
services or is instead an obligation to provide an unknown type or quantity
of goods or services might be a strong indicator of the nature of the
entity’s promise in the contract. While in either case the entity
might be required to “stand ready” to deliver the good(s) or service(s)
whenever called for by the customer or upon the occurrence of a contingent
event (e.g., snowfall), the fact that the entity will not know when or how
extensively the customer will receive the entity’s good(s) or service(s)
during the contract term may be a strong indicator that the entity is
standing ready to perform.
Example 18 in ASC 606-10-55-184 through 55-186 discusses
stand-ready obligations in health club memberships. The example notes that
the entity’s promise is to provide a service of making the health clubs
available because the extent to which a customer uses the health clubs does
not affect the amount of the remaining goods and services to which the
customer is entitled. This is consistent with the discussion in paragraph
BC160 of ASU 2014-09.
Other examples of stand-ready performance obligations may
include the following:
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Snow removal services — An entity promises to remove snow on an “as needed” basis. In this type of arrangement, the entity does not know and most likely cannot reasonably estimate whether, how often, and how much it will snow. This suggests that the entity’s promise is to stand ready to provide these services on a when-and-if-needed basis.
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Software updates and upgrades — An entity promises to make unspecified (i.e., when-and-if-available) software updates and upgrades available to a customer, and the entity has no discernible pattern of providing updates and upgrades. The nature of the entity’s promise is fundamentally one of providing the customer with assurance that any updates or upgrades developed by the entity during the period will be made available because the entity stands ready to transfer updates or upgrades when and if they become available.
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SaaS — An entity promises to make its SaaS available to the customer, and the customer has unlimited usage of the SaaS over the contract term.
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Extended warranty — A customer purchases an extended product warranty for a good (e.g., equipment), and the entity promises to remediate any issues with the product when and if problems arise. That is, the entity is standing ready to make repairs when and if needed. For further discussion, see Connecting the Dots below.
See Section 8.5.10 for
additional considerations on measuring progress toward the complete
satisfaction of a stand-ready obligation that is satisfied over time.
The above issue is addressed in Implementation Q&A 22 (compiled from previously
issued TRG Agenda Papers 16 and 25). For additional information and Deloitte’s summary
of issues discussed in the Implementation Q&As, see Appendix C.
Connecting the Dots
In Implementation Q&A 22, the FASB staff discusses
maintenance contracts under which a customer would receive repair or
maintenance services as needed over a prescribed period. The Q&A
states the following:
The staff thinks that whether the obligation is
to provide a defined good or service (or goods or services), or
instead, to provide an unknown type or quantity of goods or
services might be a strong indicator as to the nature of the
entity’s promise in the contract. The staff notes, however, that
in either case the entity might be required to “stand ready” to
deliver the good(s) or service(s) whenever the customer calls
for them or upon the occurrence of a contingent event (for
example, snowfall).
If an entity has entered into maintenance contracts to
provide maintenance services on equipment only on an as-needed basis, it
may be appropriate for the entity to account for its performance
obligations under those contracts as stand-ready obligations by
recording revenue as the stand-ready services are provided. However, the
entity must evaluate its contracts that include maintenance goods or
services to determine the nature of its promises on the basis of the
specific facts and circumstances of each contract.
Assessing whether the promise in a maintenance contract
is a stand-ready obligation will require judgment. However, an entity
may consider indicators supporting a conclusion that a stand-ready
obligation does not exist. Such indicators include, but are not limited
to, the following:
-
The contract contains a promise to provide services that is specific about amounts and timing, as opposed to a promise to provide services as needed.
-
The services vary in nature, frequency, or complexity each time they are performed.
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The goods or services are highly integrated or interrelated as a result of the complexity involved in providing them, making it difficult for another entity to take over the maintenance services.
-
Modifications to the contract often include promises for specific additional goods or services.
If an entity concludes that it does not have a
stand-ready obligation, it would account for the goods or services on
the basis of the specific promises in the contract.
5.4.3.2 Determining Whether a Contract Includes a Stand-Ready Obligation or an Obligation to Provide a Defined Amount of Goods or Services
It will sometimes be necessary to determine whether the
nature of an entity’s promise under a contract is (1) to stand ready to
provide goods or services or (2) to provide a defined amount of discrete
goods or services. A promise to stand ready to provide goods or services is
often satisfied over time as the customer benefits from being able to call
upon a resource if and when needed throughout the stand-ready obligation
period. However, an obligation to provide a defined amount of discrete goods
or services is satisfied when or as those discrete goods or services are
transferred to the customer.
An entity may be required to use judgment to distinguish
between a stand-ready obligation and an obligation to provide a defined
amount of goods or services. It will often be helpful for an entity to focus
on the extent to which a customer’s use of a resource affects the remaining
resources to which the customer is entitled. A determination that the nature
of the entity’s obligation to the customer is to provide resources as and
when required by the customer and that the customer’s future entitlement is
unaffected by the extent to which resources have already been provided is
indicative of a stand-ready obligation. In contrast, a determination that
the contract is to supply a specified number of units of the resource and
that the remaining entitlement diminishes as each unit is consumed is
indicative of an obligation to provide a defined amount of goods or
services.
Paragraph BC160 of ASU 2014-09 discusses the concept of a
stand-ready obligation as follows:
To meet [the]
objective of depicting the entity’s performance, an entity would need to
consider the nature of the promised goods or services and the nature of
the entity’s performance. For example, in a typical health club
contract, the entity’s promise is to stand ready for a period of time
(that is, by making the health club available), rather than providing a
service only when the customer requires it. In this case, the customer
benefits from the entity’s service of making the health club available.
This is evidenced by the fact that the extent to
which the customer uses the health club does not, in itself, affect
the amount of the remaining goods or services to which the customer
is entitled. In addition, the customer is obliged to pay the
consideration regardless of whether it uses the health club.
Consequently, in those cases, the entity would need to select a measure
of progress based on its service of making goods or services available
instead of when the customer uses the goods or services made available
to them. [Emphasis added]
Example 5-11
Company X enters into a software
arrangement with Customer Y, who pays up-front
nonrefundable consideration in exchange for a
software license and a specified quantity of service
credits. The credits can be redeemed for consulting
services as and when needed by the customer over a
three-year term.
Each credit is equivalent to a
predetermined number of consulting hours. The
agreement requires X to be available to provide
consulting services in exchange for credits when
requested by Y. The credits expire after the
three-year term; however, customers generally use
all of their credits.
As discussed above, for an entity to
distinguish between a stand-ready obligation and an
obligation to provide a defined amount of goods or
services, it will often be helpful to focus on the
extent to which the customer’s use of a resource
affects the remaining resources to which the
customer is entitled.
In the circumstances described, Y
pays in advance for a defined amount of consulting
services to be provided by X when and if needed by
Y. In contrast to the example in paragraph BC160 of
ASU 2014-09, when Y redeems credits for consulting
services, this does affect the amount of the
remaining services to which it is entitled,
indicating that X’s promise is to deliver specified
services rather than to stand ready.
In this example, assuming that X
does not expect to be entitled to breakage, X should
recognize revenue as the consulting services are
provided to Y for redeemed credits or when the
credits expire at the end of the three-year
arrangement.
However, if X’s obligation was to
provide an unspecified amount of consulting services
over time (e.g., an obligation to provide whatever
level of consulting services was needed by Y), a
different revenue recognition pattern would most
likely result because X’s promise would be to stand
ready. In this scenario, Y’s entitlement to future
consulting services would not be affected by the
extent to which Y had already received consulting
services.
See Section 8.5.10 for
an additional illustration of this distinction.
5.4.3.2.1 Determining Whether a SaaS Arrangement Represents a Stand-Ready Obligation or an Obligation to Provide a Specified Amount of Services
To determine the appropriate revenue recognition model to apply to its
SaaS arrangements, an entity must first determine the nature of its
promise to provide services. In some arrangements, the entity may price
a SaaS arrangement on the basis of the expected volume of usage, but it
may not always be clear whether the nature of the promise is (1) an
obligation to provide a specified amount of services (e.g., a promise to
process 5,000 transactions) or (2) a stand-ready obligation to provide
services if and when the customer needs them (e.g., a promise to make
the SaaS available throughout a specified term to process all
transactions submitted during the period).
An entity will need to carefully consider the rights and obligations in
the contract to identify the nature of the promise and to determine an
appropriate measure of the progress toward complete satisfaction of the
performance obligation.
The following factors may indicate that the nature of the entity’s
promise is an obligation to provide a specified amount of services:
-
The customer has the right to “roll over” unused volume into a future period.
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The customer’s right to use the SaaS terminates upon reaching the specified volume.
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Upon reaching the specified volume, the customer must make a separate purchasing decision with respect to additional services and the entity is not obligated to provide those services before the customer exercises its rights (e.g., the customer and entity need to enter into a contract modification to continue service).
The following factors may indicate that the nature of the entity’s
promise is to stand ready to provide the service:
-
The contract does not include any specified volumes of usage (i.e., the customer has “unlimited access” to the SaaS).
-
The specified volume is set as the maximum amount the customer can use, but it is not substantive (e.g., the limit is set as a protective measure and, in reality, is substantially higher than is actually expected to be used by the customer).
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The entity is required to stand ready to provide the service over the entire contractual period regardless of whether the customer exceeds the specified volume (i.e., the customer can continue use of the SaaS without requesting such ability from the entity, even if it has to pay an incremental fee for the excess).
If the nature of the entity’s promise is to provide a specific amount of
services, revenue is typically recognized when (or as) those services
are provided. Breakage may be considered if a customer is not expected
to use all the specified volume (see Section
8.8).
If the nature of the entity’s promise is to stand ready to provide the
SaaS, there are additional considerations related to applying the series
guidance, determining an appropriate measure of progress, and
determining how variable consideration (if present) is recognized.
5.4.3.3 Unspecified Future Goods or Services in a Software Arrangement — Timing of Revenue Recognition
There can be situations in which the contract with a customer is not specific
about what is promised to a customer. This type of contract could appear to
be a stand-ready obligation. A common example of this situation arises in
software contracts.
An entity may enter into a contract with a customer that
includes two performance obligations: (1) a license of software and (2) a
promise to provide unspecified updates and upgrades12 to the software on a “when and if available” basis. The unspecified
updates and upgrades are different from, and extend beyond, an
assurance-type warranty.
When a contract with a customer transfers the rights to unspecified future
updates, upgrades, or products, an entity is required to use judgment to
determine whether the nature of the promise (performance obligation) is
either of the following:
- To stand ready to maintain or enhance the software as needed.
- To develop and provide a new or significantly enhanced version of the software.
If the nature of the promise represents an obligation by the entity to stand
ready to maintain or enhance the software as needed to ensure that the
customer can continue to receive and consume the benefit of the software
throughout the contract term, the value to the customer is transferred over
time as the entity stands ready to perform. That is, the entity would (1)
satisfy the performance obligation over time and (2) determine the
appropriate measure of progress to recognize revenue over time.
If the nature of the promise represents an implied obligation to develop and
provide new or significantly enhanced versions of the software through
specified upgrades, the benefits of those upgrades are received and consumed
when and if they are made available to the customer. That is, the
performance obligation is only satisfied at the individual points in time
when those upgrades are delivered to the customer.
Footnotes
11
ASC 606-10-55-184 through 55-186.
12
The nature of the entity’s promise when it commits
to provide unspecified updates and upgrades to a customer differs
from the entity’s obligation when it commits to deliver specified
upgrades. This discussion addresses only unspecified updates and
upgrades. For specified upgrades, the analysis will most likely be
different since specified upgrades will often be a separate
performance obligation.