Chapter 7 — Step 4: Allocate the Transaction Price to the Performance Obligations

7.5 Allocation of Variable Consideration

As discussed in Section 7.4, there may be instances in which applying the relative stand-alone selling price allocation principle could result in the recognition of revenue that does not depict the amount of consideration to which an entity expects to be entitled in exchange for goods or services. This could occur when the criteria for allocating a discount to one or more, but not all, performance obligations are met. Another example is when a contract includes variable consideration and meets certain criteria for allocating the variable consideration to one or more, but not all, performance obligations or distinct goods or services. This additional exception to the general allocation requirements is discussed in the following paragraphs of ASC 606:

ASC 606-10

32-39 Variable consideration that is promised in a contract may be attributable to the entire contract or to a specific part of the contract, such as either of the following:

One or more, but not all, performance obligations in the contract (for example, a bonus may be contingent on an entity transferring a promised good or service within a specified period of time)
One or more, but not all, distinct goods or services promised in a series of distinct goods or services that forms part of a single performance obligation in accordance with paragraph 606-10-25-14(b) (for example, the consideration promised for the second year of a two-year cleaning service contract will increase on the basis of movements in a specified inflation index).

32-40 An entity shall allocate a variable amount (and subsequent changes to that amount) entirely to a performance obligation or to a distinct good or service that forms part of a single performance obligation in accordance with paragraph 606-10-25-14(b) if both of the following criteria are met:

The terms of a variable payment relate specifically to the entity’s efforts to satisfy the performance obligation or transfer the distinct good or service (or to a specific outcome from satisfying the performance obligation or transferring the distinct good or service).
Allocating the variable amount of consideration entirely to the performance obligation or the distinct good or service is consistent with the allocation objective in paragraph 606-10-32-28 when considering all of the performance obligations and payment terms in the contract.

32-41 The allocation requirements in paragraphs 606-10-32-28 through 32-38 shall be applied to allocate the remaining amount of the transaction price that does not meet the criteria in paragraph 606-10-32-40.

7.5.1 Codification Example of Allocating Variable Consideration

The example below, which is reproduced from ASC 606, illustrates how an entity would allocate variable consideration.

ASC 606-10

Example 35 — Allocation of Variable Consideration

55-270 An entity enters into a contract with a customer for two intellectual property licenses (Licenses X and Y), which the entity determines to represent two performance obligations each satisfied at a point in time. The standalone selling prices of Licenses X and Y are $800 and $1,000, respectively.

Case A — Variable Consideration Allocated Entirely to One Performance Obligation

55-271 The price stated in the contract for License X is a fixed amount of $800, and for License Y the consideration is 3 percent of the customer’s future sales of products that use License Y. For purposes of allocation, the entity estimates its sales-based royalties (that is, the variable consideration) to be $1,000, in accordance with paragraph 606-10-32-8.

55-272 To allocate the transaction price, the entity considers the criteria in paragraph 606-10-32-40 and concludes that the variable consideration (that is, the sales-based royalties) should be allocated entirely to License Y. The entity concludes that the criteria in paragraph 606-10-32-40 are met for the following reasons:

The variable payment relates specifically to an outcome from the performance obligation to transfer License Y (that is, the customer’s subsequent sales of products that use License Y).
Allocating the expected royalty amounts of $1,000 entirely to License Y is consistent with the allocation objective in paragraph 606-10-32-28. This is because the entity’s estimate of the amount of sales-based royalties ($1,000) approximates the standalone selling price of License Y and the fixed amount of $800 approximates the standalone selling price of License X. The entity allocates $800 to License X in accordance with paragraph 606-10-32-41. This is because, based on an assessment of the facts and circumstances relating to both licenses, allocating to License Y some of the fixed consideration in addition to all of the variable consideration would not meet the allocation objective in paragraph 606- 10-32-28.

55-273 The entity transfers License Y at inception of the contract and transfers License X one month later. Upon the transfer of License Y, the entity does not recognize revenue because the consideration allocated to License Y is in the form of a sales-based royalty. Therefore, in accordance with paragraph 606-10-55-65, the entity recognizes revenue for the sales-based royalty when those subsequent sales occur.

55-274 When License X is transferred, the entity recognizes as revenue the $800 allocated to License X.

Case B — Variable Consideration Allocated on the Basis of Standalone Selling Prices

55-275 The price stated in the contract for License X is a fixed amount of $300, and for License Y the consideration is 5 percent of the customer’s future sales of products that use License Y. The entity’s estimate of the sales-based royalties (that is, the variable consideration) is $1,500 in accordance with paragraph 606-10-32-8.

55-276 To allocate the transaction price, the entity applies the criteria in paragraph 606-10-32-40 to determine whether to allocate the variable consideration (that is, the sales-based royalties) entirely to License Y. In applying the criteria, the entity concludes that even though the variable payments relate specifically to an outcome from the performance obligation to transfer License Y (that is, the customer’s subsequent sales of products that use License Y), allocating the variable consideration entirely to License Y would be inconsistent with the principle for allocating the transaction price. Allocating $300 to License X and $1,500 to License Y does not reflect a reasonable allocation of the transaction price on the basis of the standalone selling prices of Licenses X and Y of $800 and $1,000, respectively. Consequently, the entity applies the general allocation requirements in paragraphs 606-10-32-31 through 32-35.

55-277 The entity allocates the transaction price of $300 to Licenses X and Y on the basis of relative standalone selling prices of $800 and $1,000, respectively. The entity also allocates the consideration related to the sales-based royalty on a relative standalone selling price basis. However, in accordance with paragraph 606-10-55-65, when an entity licenses intellectual property in which the consideration is in the form of a sales-based royalty, the entity cannot recognize revenue until the later of the following events: the subsequent sales occur or the performance obligation is satisfied (or partially satisfied).

55-278 License Y is transferred to the customer at the inception of the contract, and License X is transferred three months later. When License Y is transferred, the entity recognizes as revenue the $167 ($1,000 ÷ $1,800 × $300) allocated to License Y. When License X is transferred, the entity recognizes as revenue the $133 ($800 ÷ $1,800 × $300) allocated to License X.

55-279 In the first month, the royalty due from the customer’s first month of sales is $200. Consequently, in accordance with paragraph 606-10-55-65, the entity recognizes as revenue the $111 ($1,000 ÷ $1,800 × $200) allocated to License Y (which has been transferred to the customer and is therefore a satisfied performance obligation). The entity recognizes a contract liability for the $89 ($800 ÷ $1,800 × $200) allocated to License X. This is because although the subsequent sale by the entity’s customer has occurred, the performance obligation to which the royalty has been allocated has not been satisfied.

7.5.2 Allocating Variable Consideration and Discounts

In some circumstances, a contract may include both a discount and variable consideration. The revenue standard includes guidance on allocating discounts to only one or some, but not all, performance obligations, which differs from the guidance on allocating variable consideration to one or some, but not all, performance obligations or distinct goods or services. Because discounts may be in the form of variable consideration (i.e., the revenue standard cites discounts as examples of variable consideration), stakeholders have questioned which guidance should be applied when an entity’s contract with a customer includes a variable discount.

An entity would first determine whether a discount is variable consideration. If the entity concludes that the discount is variable consideration, it would apply the variable consideration allocation guidance in ASC 606-10-32-39 through 32-41 if the related criteria are met and then apply the allocation guidance in ASC 606-10-32-28 through 32-38 (which includes the guidance on allocating discounts) to the remaining amount of the transaction price. If the discount is not variable, the entity would look to the discount allocation guidance to determine how to allocate the discount.

The above issue is addressed in Q&A 38 (compiled from previously issued TRG Agenda Papers 31 and 34) of the FASB staff’s Revenue Recognition Implementation Q&As (the “Implementation Q&As”). For additional information and Deloitte’s summary of issues discussed in the Implementation Q&As, see Appendix C.

There are several approaches to determining the amount that represents a discount rather than variable consideration. However, an entity should ensure that the approach selected results in an allocation that is consistent with the criteria in ASC 606-10-32-40, including the allocation objective in ASC 606-10-32-28.

The approaches are as follows:

Approach 1 — An entity should determine the remaining discount, if any, that is a fixed discount (i.e., the amount of the discount that is present in the contract regardless of the outcome of the uncertainties that give rise to variable consideration). In determining the fixed discount in an arrangement, the entity should compare the combined stand-alone selling prices of the performance obligations with the sum of the fixed consideration and any potential variable consideration, including variable consideration that has been specifically allocated to a performance obligation. In determining potential variable consideration (i.e., the top end of the potential consideration), the entity should not include amounts that are not realistic outcomes (i.e., there should be substance to the potential variable consideration). Accordingly, when the likelihood of receiving certain amounts of variable consideration is sufficiently low, the entity should exclude those amounts from the transaction price when determining the portion of the discount that is essentially a fixed discount.
Approach 2 — An entity should calculate the remaining discount by comparing the combined stand-alone selling prices of the performance obligations with the transaction price. The transaction price should include the fixed element plus an estimate of the variable consideration determined in accordance with ASC 606-10-32-8; that estimate should be made before the application of the constraints under ASC 606-10-32-11 or ASC 606-10-55-65.
Approach 3 — An entity should calculate the remaining discount by comparing the combined stand-alone selling prices of the performance obligations with the transaction price. The transaction price should include the fixed element plus an estimate of the variable consideration determined in accordance with ASC 606-10-32-8, subject to the variable consideration constraints under ASC 606-10-32-11 or ASC 606-10-55-65.

The example below illustrates the application of the above approaches.

Example 7-16

Consider the following:

An entity enters into a contract with a customer that includes Product A and Product B.
The stand-alone selling price of Product A is $100, and the stand-alone selling price of Product B is $200.
The contract includes fixed consideration of $225 and a performance bonus of $50 if certain conditions are met.
The performance bonus is related to the productivity enhancements that Product B achieves.

As indicated above, the contract includes both a discount and variable consideration. Because of the performance bonus, the determination of the transaction price will result in either of the following possible outcomes:

When a contract includes both a discount and variable consideration, an entity would first apply the variable consideration allocation guidance in ASC 606-10-32-39 through 32-41 to determine whether the criteria for allocating the variable consideration to one or more (but not all) of the performance obligations are met. After considering the guidance on allocating variable consideration, the entity would look to the discount allocation guidance to determine how to allocate the discount. ASC 606-10-32-41 establishes a hierarchy that requires an entity to identify and allocate variable consideration to performance obligations before applying other guidance (e.g., the guidance on allocating a discount).

Because the performance bonus is related to productivity enhancements achieved by Product B, the entity concludes that the criterion in ASC 606-10-32-40(a) is met and allocates the variable consideration entirely to Product B. The entity would then apply the guidance in ASC 606-10-32-28 through 32-38 to allocate the remaining consideration to Product A and Product B. That allocation should be consistent with the criterion in ASC 606-10-32-40(b).

Approach 1 would result in a fixed discount of $25 (i.e., the total stand-alone selling price of $300 minus the total potential consideration of $275) that would be allocated to Product A and Product B in accordance with the guidance in ASC 606-10-32-36 through 32-38 as follows:

Under Approach 1, $91.67 would be recognized when control of Product A is transferred to the customer. If the entity concludes that it is probable that including the performance bonus in the transaction price will not result in a significant revenue reversal, the entity would recognize $183.33 as revenue when control of Product B is transferred to the customer. Any subsequent changes in the transaction price would be attributed entirely to Product B.

Under Approach 2, if the amounts discussed above are used across a portfolio of homogeneous contracts and the entity estimates that it would be entitled to a performance bonus of $40 (determined in accordance with ASC 606-10-32-8(a)), a remaining discount of $35 (i.e., the total stand-alone selling price of $300 minus the expected consideration of $265) would be allocated to Product A and Product B in accordance with the guidance in ASC 606-10-32-36 through 32-38 as follows:

Under Approach 2, $88.33 would be recognized when control of Product A is transferred to the customer. If the entity concludes that it is probable that including the performance bonus in the transaction price will not result in a significant revenue reversal, the entity would recognize $186.67 as revenue when control of Product B is transferred to the customer. Any subsequent changes in the transaction price would be attributed entirely to Product B.

Under Approach 3, if the amounts discussed above are used across a portfolio of homogeneous contracts and only $30 of the performance bonus of $50 is included in the transaction price (i.e., the constrained amount of variable consideration), a remaining discount of $45 (i.e., the total stand-alone selling price of $300 minus the constrained transaction price of $255) would be allocated to Product A and Product B in accordance with the guidance in ASC 606-10-32-36 through 32-38 as follows:

Under Approach 3, $85 would be recognized when control of Product A is transferred to the customer. If the entity concludes that it is probable that including the performance bonus in the transaction price will not result in a significant revenue reversal, the entity would recognize $190 as revenue when control of Product B is transferred to the customer. Any subsequent changes in the transaction price would be attributed entirely to Product B.

The revenue standard does not prescribe a method for determining the amount of remaining consideration to allocate once variable consideration has been allocated in accordance with ASC 606-10-32-39 through 32-41. An entity should use judgment and consider a contract’s specific facts and circumstances when deciding which of the above approaches would best achieve the allocation objective, which is to allocate the transaction price to each performance obligation in an amount that depicts the amount of consideration to which the entity expects to be entitled in exchange for transferring the promised goods or services.

In the determination of which approach to use, it may be relevant to consider whether the stand-alone selling price of one or more of the goods or services is actually a range of amounts (which may be the case if variable consideration is appropriately allocated to one or more, but not all, performance obligations in a contract). For instance, if the stand-alone selling price of B in the above example was determined to be between $150 and $200, Approach 1 may be the most appropriate approach. This is because the discount allocated to both A and B under either outcome results in an amount of revenue recognized for each performance obligation that is (1) consistent with the overall allocation objective and (2) based on the relative stand-alone selling prices of A and B. Depending on the specific facts and circumstances, different approaches may be more or less appropriate.

It will also be important to evaluate the potential outcomes of any resulting allocation approach. For example, in situations involving both a fixed discount and variable consideration (i.e., the total potential transaction price is less than the aggregated stand-alone selling prices), we do not think that an allocation that could result in the allocation of consideration to a performance obligation in an amount that exceeds the performance obligation’s stand-alone selling price would be consistent with the overall allocation objective.

7.5.3 Allocating Variable Consideration to a Series of Distinct Services

The revenue standard includes a provision that requires an entity to identify as a performance obligation a promise to transfer a “series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer” (see Section 5.3.3). As noted above, the revenue standard requires the allocation of variable consideration to one or more, but not all, of the distinct goods or services promised in a series of distinct goods or services that forms part of a single performance obligation in accordance with ASC 606-10-25-14(b) (the “series guidance”) when the criteria in ASC 606-10-32-40 are met.

Stakeholders have questioned whether an entity is required to allocate variable consideration on the basis of the relative stand-alone selling price of each distinct good or service in a series accounted for as a single performance obligation under ASC 606-10-25-14(b). If an entity is required to do so, applying the series guidance would not result in the relief contemplated by the FASB and IASB, as discussed in paragraph BC114 of ASU 2014-09. Such an outcome would largely nullify the benefits of qualifying for the series guidance since the same amount of consideration would most likely be allocated to each distinct good or service that is “substantially the same” (because goods or services that are substantially the same would most likely have the same stand-alone selling prices). However, a distinct increment of service that forms part of a single performance obligation may be substantially the same but have varying stand-alone selling prices (see Section 5.3.3.1 on evaluating whether distinct goods and services accounted for under the series guidance are substantially the same), and allocating the variable consideration (or changes in variable consideration) entirely to this discrete increment of service may be consistent with the allocation objective in ASC 606-10-32-28.

As stated in ASC 606-10-32-29, the general allocation principle does not apply if the criteria in ASC 606-10-32-39 through 32-41 are met. The FASB and IASB staffs concluded that a relative stand-alone selling price allocation is not required to meet the allocation objective when it is related to the allocation of variable consideration to a distinct good or service in a series.

The application of this allocation concept is further explained in paragraph BC285 of ASU 2014-09, which states, in part:

Consider the example of a contract to provide hotel management services for one year (that is, a single performance obligation in accordance with paragraph 606-10-25-14(b)) in which the consideration is variable and determined based on two percent of occupancy rates. The entity provides a daily service of management that is distinct, and the uncertainty related to the consideration also is resolved on a daily basis when the occupancy occurs. In those circumstances, the Boards did not intend for an entity to allocate the variable consideration determined on a daily basis to the entire performance obligation (that is, the promise to provide management services over a one-year period). Instead, the variable consideration should be allocated to the distinct service to which the variable consideration relates, which is the daily management service.

The above example illustrates a scenario in which the same service (hotel management) is performed each day for varying amounts (because occupancy rates change each day). If it was determined that each day of service should have the same stand-alone selling price, an entity might have to estimate the total transaction price for the contract (on the basis of the expected occupancy rates and associated fees over the term of the arrangement) and allocate that transaction price to each distinct increment of service. However, as explained in paragraph BC285, this was not the boards’ intent. Rather, variability in the actual amounts earned each day based on occupancy rates can be allocated to that day’s service without regard to a perceived stand-alone selling price of the service provided. In all scenarios, however, the resulting allocation would need to meet the overall allocation objective.

The guidance in ASC 606-10-32-39 through 32-41 specifically addresses the allocation of variable consideration to one or more, but not all, performance obligations (or distinct goods or services promised in a series) but is silent on whether a similar allocation of fixed consideration is acceptable. However, Example A of Implementation Q&A 45 (compiled from previously issued TRG Agenda Papers 39 and 44) includes a declining fixed price per unit for variable quantities. In that example, it would be acceptable to allocate the fixed price attributed to each variable quantity even when the fixed price per unit declines over time. This is because such consideration represents variable consideration and doing so would meet the allocation objective when (1) the declining price is intended to reflect changes in market terms or (2) the changes in price are substantive and linked to changes in either the entity’s cost of fulfilling the obligation or the value provided to the customer.

Although Example A illustrates a situation in which there is a declining fixed unit price for variable quantities, we believe that the same concepts apply to the allocation of fixed elements of consideration provided that the contract also includes elements of variable consideration that meet the criteria to be allocated to one or more, but not all, performance obligations. That is, we believe that an entity must consider the total transaction price (i.e., both fixed and variable components) when performing an evaluation under ASC 606-10-32-40(b) to determine whether its application of the variable consideration allocation guidance described in that subparagraph is consistent with the overall allocation objective in ASC 606-10-32-28. Specifically, if the fixed consideration declines over time, allocating less of the fixed consideration to each successive period of a contract could be consistent with the objective behind allocating the total transaction price (i.e., the overall allocation objective in ASC 606-10-32-28) when (1) declining fixed consideration is linked to changes in the entity’s cost of providing the service or changes in the value provided to the customer and (2) the total transaction price also includes elements of variable consideration that meet the criteria to be allocated to one or more, but not all, distinct goods or services in a series.

Example 7-17

Entity L enters into a contract to provide 10 years of management service for an apartment complex to Customer C. In exchange for the service provided, C pays the following fees to L:

Base management fee — Fixed annual fee that declines by 1 percent each year as a result of expected efficiencies and other expected cost reductions.
Incentive fee — Variable annual fee based on 3 percent of C’s rental revenues.
Reimbursement — Payment of certain fulfillment costs incurred by L.

Entity L concludes that the management service meets the criteria in ASC 606-10-25-15 to be accounted for as a series of distinct services.

Under these facts, L can allocate the fixed consideration in the contract to each distinct increment of management service. The base management fee declines on an annual basis as a result of expected efficiencies and other expected cost reductions. In addition, there are variable elements of consideration that meet the criteria to be allocated to one or more, but not all, distinct goods or services in a series. For these reasons, we believe that L would meet the overall allocation objective in ASC 606-10-32-28 by allocating each annual amount of the base management fee, in combination with the variable consideration (the annual incentive fee, which is further discussed below), to a distinct annual year of service. Consequently, L will recognize less revenue from the base management fee in each year of the contract.

Entity L can allocate the variable consideration in the contract (i.e., the annual incentive fee) to each distinct increment of management service. The variable consideration in this example (i.e., the annual incentive fee) is similar to the variable payments in Example C of Implementation Q&A 45. The variability associated with the incentive fee is directly related to the distinct increments of management service provided by L (i.e., the rental income generated from the management service). Because the variability is related to each distinct increment of management service, allocating each annual incentive fee to a distinct annual year of service is consistent with the allocation objective in ASC 606-10-32-28.

Further, if the reimbursement of L’s fulfillment costs is directly related to L’s efforts to fulfill its promise to C, L can allocate that reimbursement to the period in which the costs were incurred. Doing so in that case would be consistent with the allocation objective in ASC 606-10-32-28.

Connecting the Dots

The example above illustrates a situation in which a single performance obligation results in multiple forms of consideration (i.e., both fixed consideration and multiple sources of variable consideration). As a result of the allocation conclusions above, the actual revenue recognized is likely to fluctuate during the contract period as the uncertainties associated with the sources of variable consideration are resolved. Consequently, revenue might be recognized in a pattern that suggests that multiple measures of progress are being used to determine the entity’s pattern of performance. As discussed in Section 8.5.3, an entity should use only a single measure of progress for each performance obligation identified in a contract. However, the pattern of revenue recognition that results from the allocations described in the example above is not attributable to the selection of multiple methods of measuring progress as part of step 5 (i.e., the pattern does not reflect multiple attribution). Rather, the pattern arises from the application of the transaction price allocation guidance as part of step 4.

7.5.3.1 Allocating Variable Consideration in Cloud-Based or Hosted Software Arrangements

Entities that sell cloud-based or hosted software solutions (e.g., SaaS arrangements)6 often require the customer to pay them a variable amount, usually based on the underlying usage of the SaaS technology. ASC 606 generally requires entities to estimate variable consideration subject to a constraint,7 but it also provides a practical expedient and a variable consideration allocation exception. In addition, while ASC 606 includes an exception to the general model for variable consideration in the form of a sales- or usage-based royalty related to licenses of IP,8 SaaS arrangements often do not qualify for the exception because a license is typically not transferred to the customer in such cases (i.e., the contracts are often hosting arrangements that do not meet the criteria in ASC 985-20-15-5 to be considered a license and are therefore accounted for as a service).

The next sections provide interpretive guidance intended to help entities address certain challenges associated with applying the revenue model in ASC 606 to SaaS arrangements that include variable consideration. All of the examples assume that (1) SaaS is the only promise in the contract and (2) the SaaS performance obligation meets the requirements to be recognized over time because the customer “simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs,” in accordance with ASC 606-10-25-27(a).

7.5.3.1.1 Applying the Invoice Practical Expedient to Stand-Ready SaaS Arrangements With Usage-Based Variable Consideration

ASC 606-10-55-18 provides the following practical expedient (the “invoice practical expedient”), which can be applied to performance obligations that are satisfied over time:

As a practical expedient, if an entity has a right to consideration from a customer in an amount that corresponds directly with the value to the customer of the entity’s performance completed to date (for example, a service contract in which an entity bills a fixed amount for each hour of service provided), the entity may recognize revenue in the amount to which the entity has a right to invoice.

The invoice practical expedient allows an entity to recognize revenue in the amount of consideration to which the entity has the right to invoice if such amount corresponds directly to the value transferred to the customer. That is, the invoice practical expedient cannot be applied in all circumstances because the amount that an entity has the right to invoice does not always correspond to the value of the entity’s performance to date. Therefore, an entity should demonstrate its ability to apply the invoice practical expedient to performance obligations satisfied over time. In addition, because the use of the invoice practical expedient must faithfully depict the entity’s measure of progress toward completion, the expedient can only be applied to performance obligations satisfied over time (not at a point in time).

We believe that if a stand-ready SaaS arrangement (1) has a pricing structure that is solely variable on the basis of the customer’s SaaS usage, (2) is priced at the same fixed rate per usage, and (3) gives the entity the right to invoice the customer for its usage as the usage occurs, the invoice practical expedient may be applied. In such cases, the amount of revenue for which the entity has the right to invoice may reflect the value the customer has obtained from the SaaS during the period because it is a fixed rate based on the volume of the customer’s SaaS usage. Accordingly, an entity with this type of arrangement is not required to estimate the amount of variable consideration to which it would be entitled at contract inception and instead can recognize revenue as the customer’s usage occurs (provided that it also has the right to invoice).

The conclusion above may not be appropriate when (1) there are fixed fees in addition to the usage-based fees, (2) there are substantive minimum usage requirements, (3) the usage price or rate varies during the contract period, or (4) up-front or back-end fees are charged. In those circumstances, it may be challenging to demonstrate that the amount the entity has the right to invoice corresponds to the value the customer has received to date. However, the invoice practical expedient may not necessarily be precluded in the following scenarios (not all-inclusive):

The amount of fixed consideration the entity has a right to invoice does not change from period to period, and the customer’s usage is expected to be consistent from period to period.
The customer is expected to significantly exceed any minimum usage requirements.
The usage rate changes solely on the basis of the Consumer Price Index or another metric that reflects an increase or decrease in value and directly correlates to the benefits received by the customer.
The up-front or back-end fees are insignificant relative to the other expected consideration in the arrangement so that the amount the entity has the right to invoice is commensurate with the value the customer has received to date.

7.5.3.1.2 Applying the Variable Consideration Allocation Exception to Stand-Ready SaaS Arrangements With Usage-Based Variable Consideration

Generally, ASC 606 requires an entity to allocate the transaction price to each performance obligation on a relative stand-alone selling price basis. However, the guidance provides an exception to the general allocation principle that applies specifically to variable consideration (the “variable consideration allocation exception”). Specifically, ASC 606-10-32-39(b) states that variable consideration may be attributable to “[o]ne or more, but not all, distinct goods or services promised in a series of distinct goods or services that forms part of a single performance obligation.” In addition, ASC 606-10-32-40 states the following:

An entity shall allocate a variable amount (and subsequent changes to that amount) entirely to a performance obligation or to a distinct good or service that forms part of a single performance obligation in accordance with paragraph 606-10-25-14(b) if both of the following criteria are met:

The terms of a variable payment relate specifically to the entity’s efforts to satisfy the performance obligation or transfer the distinct good or service (or to a specific outcome from satisfying the performance obligation or transferring the distinct good or service).
Allocating the variable amount of consideration entirely to the performance obligation or the distinct good or service is consistent with the allocation objective in paragraph 606-10-32-28 when considering all of the performance obligations and payment terms in the contract.

If an entity elects not to apply the invoice practical expedient or is precluded from applying such expedient to its stand-ready SaaS arrangements, it may be required to apply the variable consideration allocation exception to usage-based fees depending on the facts and circumstances. Because a SaaS arrangement would typically be a series of distinct services that represent a single performance obligation, an entity that does not apply the invoice practical expedient would apply the variable consideration allocation exception if the conditions in ASC 606-10-32-40 are met. An entity that receives variable consideration based on usage would typically meet the condition in ASC 606-10-32-40(a) because the usage is usually associated with a specific outcome (e.g., the transaction is processed, or storage capacity is used). However, an entity must carefully evaluate its pricing structure to determine whether allocating variable consideration to a distinct service (e.g., each day that SaaS is provided) is consistent with the allocation objective.

Example 7-18

Application of the Variable Consideration Allocation Exception to Stand-Ready SaaS Arrangements With Variable Consideration That Is Solely Usage-Based

Entity A sells a SaaS platform that is a stand-ready performance obligation. The pricing structure for its SaaS is based solely on usage (e.g., $1 for each transaction processed). We believe that if a stand-ready SaaS arrangement has a variable pricing structure based on the customer’s SaaS usage and the SaaS is priced at a fixed rate per usage, the variable consideration allocation exception may be applied.9 This is because (1) the usage-based fees are related to a specific outcome and (2) allocation of the variable consideration to each distinct service period (e.g., each day) would meet the allocation objective (i.e., the usage-based pricing represents the amount of consideration to which the entity expects to be entitled upon the transfer of each and every distinct service, which is based on each increment of time within the series). Accordingly, A is not required to estimate the amount of variable consideration to which it would be entitled at contract inception and instead can recognize revenue as the customer’s usage occurs.

However, the conclusion above may not be appropriate if the usage price or rate varies during the contract period, and an entity should give careful consideration to variable fees that increase or decrease on the basis of usage (e.g., tiered pricing). If the usage-based fees that would be allocated to each distinct service would not represent the amount of consideration to which the entity expects to be entitled upon the transfer of each distinct service (i.e., the increase or decrease in the fee is not commensurate with the efforts required by the entity to satisfy each distinct service or does not reflect the value of the specific outcome associated with usage), it may not be appropriate to conclude that the requirements to use the variable consideration allocation exception are met.

Example 7-19

Application of the Variable Consideration Allocation Exception to Stand-Ready SaaS Arrangements With Both Fixed Consideration and Usage-Based Variable Consideration

Entity B sells a SaaS platform that is a stand-ready performance obligation. The pricing structure for its SaaS includes a fixed component that is charged regardless of usage (e.g., a flat fee of $100,000 for an annual subscription) and a variable component based on usage (e.g., $1 for each transaction processed). If B uses a ratable (i.e., time-based) measure of progress for its stand-ready SaaS arrangements, the fixed consideration (e.g., $100,000) would be recognized ratably over the contractual period. In addition, as discussed in Example 7-18, we believe that if a stand-ready SaaS arrangement has a variable pricing structure based on the customer’s SaaS usage and the SaaS is priced at a fixed rate per usage, the variable consideration allocation exception may be applied. This is because (1) the usage-based fees are related to a specific outcome and (2) allocation of the variable consideration to each distinct service period (e.g., each day) would meet the allocation objective (i.e., the usage-based pricing would represent the amount of consideration to which the entity expects to be entitled upon the transfer of each and every distinct service, which is based on each increment of time within the series). Accordingly, B is not required to estimate the amount of variable consideration to which it would be entitled at contract inception and instead can recognize the variable consideration as the customer’s usage occurs (with the fixed consideration recognized ratably).

As in Example 7-18, the conclusion above may not be appropriate if the usage price or rate varies during the contract period.

Example 7-20

Application of the Variable Consideration Allocation Exception to Stand-Ready SaaS Arrangements With Overage Fees and Minimums That Reset Monthly

Entity C sells a SaaS platform that is a stand-ready performance obligation and concludes that a ratable measure of progress for the performance obligation is appropriate. The pricing structure for its SaaS includes a fixed component that is based on a predetermined amount of usage (i.e., a minimum usage requirement) and a variable component that is charged if the customer exceeds the predetermined amount (i.e., “overage fees”). In one of its arrangements, C sells a one-year subscription that has a minimum usage requirement of 100,000 transactions every month. The subscription is priced at $100,000 per month ($1 for each transaction processed); if the number of transactions exceeds 100,000, additional transactions processed are also priced at $1 each. If the customer has fewer than 100,000 transactions in any month, the shortfall is not carried forward (e.g., if the customer only has 90,000 transactions in a particular month, it must still pay $100,000 that month and the next month’s minimum is still 100,000 transactions). Therefore, the total fixed consideration is $1.2 million ($100,000 × 12 months), which is recognized ratably over the contractual term.

An entity’s ability to apply the variable consideration allocation exception when a fixed component and overage fees exist depends on whether the minimum usage requirements are the same in each period, whether the overage fees are a fixed rate per usage, and how often the minimum usage requirements are “reset.” If the minimum usage requirements are the same in each period, overage fees are a fixed rate per usage, and minimum usage requirements are reset frequently throughout the entity’s reporting period (e.g., monthly), the overage fees incurred in such periods typically qualify for the variable consideration allocation exception. This is because (1) the usage-based fees are related to a specific outcome and (2) allocation of the variable consideration to each distinct service period (e.g., each month) would meet the allocation objective (i.e., the usage-based pricing represents the amount of consideration to which the entity expects to be entitled upon the transfer of each and every distinct service, which is based on each increment of time within the series).

In assessing the allocation objective, C determines that any overage fees for a particular month are solely associated with that month and reflect the value of the specific outcome associated with the overage. Accordingly, C is not required to estimate the amount of variable consideration to which it would be entitled at contract inception and instead can recognize the variable consideration as the customer’s usage occurs (with the fixed consideration recognized ratably).

Example 7-21

Application of the Variable Consideration Allocation Exception to Stand-Ready SaaS Arrangements With Overage Fees and a Minimum That Does Not Reset

Assume the same facts as in Example 7-20 except that in one of its arrangements, Entity C sells a one-year subscription that has an annual minimum usage requirement of 1.2 million transactions. The subscription is priced at a fixed fee of $1.2 million ($1 for each transaction processed); if the number of transactions exceeds 1.2 million, additional transactions processed are also priced at $1 each. Therefore, the total fixed consideration is $1.2 million, which is recognized ratably over the contractual term ($100,000 each month).

Because the minimum usage requirements do not reset, the overage fees incurred in the latter part of the year would not qualify for the variable consideration allocation exception. While the usage-based fees are related to a specific outcome, allocation of the variable consideration to each distinct service period (e.g., the latter month or months of the year) would not meet the allocation objective (i.e., the usage-based pricing does not represent the amount of consideration to which the entity expects to be entitled upon the transfer of each and every distinct service, which is based on each increment of time within the series). In assessing the allocation objective, C determines that any overage fees for a particular month (1) would not be solely associated with that month and (2) would not reflect the value of the specific outcome associated with the overage. For example, if the customer has 110,000 transactions in each month, total consideration would be $1.32 million (110,000 × $1 × 12 months) and $100,000 of fixed consideration would be recognized in each month. The overage fees would be $120,000 ($1.32 million – $1.2 million). However, if the overage fees were recognized in the specific month they related to, they would be recognized in the last 2 months of the year ($10,000 in month 11 and $110,000 in month 12). Therefore, even though the number of transactions would be the same in each month (i.e., the benefits received in the last two months are similar to those received in the first 10 months because the usage is the same), more revenue would be recognized in the last 2 months ($100,000 recognized in months 1–10, $110,000 recognized in month 11, and $210,000 recognized in month 12).

Accordingly, C would generally be required to estimate the amount of variable consideration to which it would be entitled at contract inception and to recognize both fixed and variable consideration ratably10 over the contract term, subject to the variable consideration constraint.11

Example 7-22

Application of the Variable Consideration Allocation Exception to Stand-Ready SaaS Arrangements With Overage Fees and Minimums That Reset Annually

Assume the same facts as in Example 7-20 except that in one of its arrangements, Entity C sells a three-year subscription that has an annual minimum usage requirement of 1.2 million transactions. The subscription is priced at $1.2 million per year ($1 for each transaction processed); if the number of transactions exceeds 1.2 million, the additional transactions are also priced at $1 each. If the customer has fewer than 1.2 million transactions in any year, the shortfall is not carried forward (e.g., if the customer only has 1 million transactions in a particular year, it must still pay $1.2 million and the next year’s minimum is still 1.2 million transactions). Therefore, the total fixed consideration is $3.6 million ($1.2 million × 3 years), which is recognized ratably over the contractual term ($100,000 in each month).

Since the minimum usage requirements are the same for each year, overage fees are a fixed rate per usage, and minimum usage requirements are reset each year, the overage fees incurred for a particular annual period typically qualify for the variable consideration allocation exception and can therefore be allocated to that year’s service. This is because (1) the usage-based fees are related to a specific outcome and (2) the allocation of variable consideration to each distinct service period (e.g., each year) meets the allocation objective (i.e., the usage-based pricing represents the amount of consideration to which the entity expects to be entitled upon the transfer of each and every distinct service, which is based on each annual increment of time within the series). In assessing the allocation objective, C determines that any overage fees for a particular year are solely associated with that year and reflect the value of the specific outcome associated with the overage.

However, as in Example 7-21, because the minimum usage requirements do not reset frequently (e.g., monthly), the overage fees incurred in the latter part of each year would not qualify for the variable consideration allocation exception for the periods within each year (e.g., each month within the year). While the usage-based fees are related to a specific outcome, the allocation of variable consideration to each distinct service period (e.g., the latter month or months of the year) would not meet the allocation objective (i.e., the usage-based pricing does not represent the amount of consideration to which the entity expects to be entitled upon the transfer of each and every distinct service, which is based on each increment of time within the series). In assessing the allocation objective, C determines that any overage fees for a particular month (1) are not solely associated with that month and (2) do not reflect the value of the specific outcome associated with the overage.

Accordingly, C would generally be required to estimate the amount of variable consideration to which it would be entitled in each year and to recognize both fixed and variable consideration ratably12 over each annual period, subject to the variable consideration constraint. However, because the allocation objective is met on an annual basis (i.e., the overage fees for each year (1) are solely associated with that year and (2) reflect the value of the specific outcome associated with the overage for that year), the overages for a particular year can be recognized that year. For example, if C expects $100,000 in overage fees in the first year, $120,000 in overage fees in the second year, and $150,000 in overage fees in the third year, it may recognize $1.3 million13 ratably in the first year, $1.32 million14 ratably in the second year, and $1.35 million15 ratably in the third year, subject to the variable consideration constraint.16

Example 7-23

Application of the Variable Consideration Allocation Exception to Stand-Ready SaaS Arrangements With Overage Fees and Minimums That Increase Monthly

Assume the same facts as in Example 7-20 except that in one of its arrangements, Entity C sells a one-year subscription that has an increasing minimum usage requirement in every month, which is priced at $1 for each transaction processed. If the number of transactions exceeds the minimum requirement, the additional transactions processed are also priced at $1 each. The minimum usage starts at 100,000 transactions in the first month and increases by 10,000 in each month of the year (210,00017 in the last month). Therefore, the total fixed consideration is $1.86 million,18 which is recognized ratably over the contractual term.

Because the minimum usage requirements change in each month, C must carefully evaluate whether it would qualify for the variable consideration allocation exception. While the usage-based fees are related to a specific outcome, allocation of the variable consideration to each distinct service period (e.g., each month) would not be likely to meet the allocation objective (i.e., the usage-based pricing is not likely to represent the amount of consideration to which the entity expects to be entitled upon the transfer of each and every distinct service, which is based on each increment of time within the series). In assessing the allocation objective, C determines that any overage fees for a particular month are not likely to (1) be solely associated with that month or (2) reflect the value of the specific outcome associated with the overage. For example, fixed consideration of $155,000 would be recognized in each month ($1.86 million ÷ 12 months). However, if the customer had 200,000 transactions in each month, the amount of overage fees would be greater in the earlier months ($100,00019 in the first month, $90,00020 in the second month, and so on). Therefore, even though the number of transactions would be the same in each month, more consideration would be recognized in the earlier months (for a total of $255,00021 recognized in the first month, $245,00022 recognized in the second month, and so on).

Accordingly, C would generally be required to estimate the amount of variable consideration to which it would be entitled at contract inception and to recognize both fixed and variable consideration ratably23 over the contract term, subject to the variable consideration constraint.24

Example 7-23A

Application of the Variable Consideration Allocation Exception to Stand-Ready SaaS Arrangements With Overage Fees and Minimums That Increase Monthly — Nonsubstantive Minimums

Assume the same facts as in Example 7-23 except that Entity C expects that the customer will exceed the monthly minimum each month of the contract. Entity C concludes that the monthly minimum is not substantive and that therefore, both fixed consideration and variable consideration are in-substance variable consideration.

In a manner similar to our views in Example 7-18, we believe that if a stand-ready SaaS arrangement has a variable pricing structure based on the customer’s SaaS usage and the SaaS is priced at a fixed rate per usage, the variable consideration allocation exception may be applied when fixed monthly minimums are not substantive (i.e., are expected to be exceeded each month).25 In assessing the allocation objective, C determines that any consideration (including both monthly minimums and overages) for a particular month is solely associated with that month and reflects the value of the specific outcome associated with the monthly minimum and overage fees.

Accordingly, C is not required to estimate the amount of variable consideration to which it would be entitled at contract inception and instead can recognize revenue related to both fixed and variable consideration as the customer’s usage occurs.

Example 7-24

Application of the Variable Consideration Allocation Exception to Stand-Ready SaaS Arrangements With Overage Fees and Minimums That Carry Over

Assume the same facts as in Example 7-20 except that in one of its arrangements, Entity C sells a one-year subscription that specifies a minimum usage requirement of 100,000 transactions in every month. The subscription is priced at $100,000 per month ($1 for each transaction processed); if the number of transactions exceeds 100,000, the additional transactions processed are also priced at $1 each. However, if the customer has fewer than 100,000 transactions in any month, the shortfall is carried over to the following month (e.g., if the customer only has 90,000 transactions in the first month, it must still pay $100,000 for that month but the next month’s minimum becomes 110,000 transactions; and if in the second month the customer only has 95,000 transactions, it must still pay $100,000 for that month but the next month’s minimum becomes 115,000. However, if in the third month the customer has 120,000 transactions, it will pay $100,000 for that month and pay $5,000 for the overage). In addition, any shortfall at the end of the year is not carried forward upon renewal. Therefore, the total fixed consideration is $1.2 million ($100,000 × 12 months), which is recognized ratably over the contractual term.

Because the minimum usage requirements could change in each month, C must carefully evaluate whether it would qualify for the variable consideration allocation exception. As in Example 7-23, while the usage-based fees are related to a specific outcome, allocation of the variable consideration to each distinct service period (e.g., each month) may not meet the allocation objective (i.e., the usage-based pricing may not represent the amount of consideration to which the entity expects to be entitled upon the transfer of each and every distinct service, which is based on each increment of time within the series). Therefore, if the minimum usage requirements change monthly, any overage fees for a particular month may not (1) be solely associated with that month or (2) reflect the value of the specific outcome associated with the overage. Accordingly, C may be required to estimate the amount of variable consideration to which it would be entitled at contract inception and to recognize both fixed and variable consideration ratably over the contract term, subject to the variable consideration constraint.

However, if C expects the customer to exceed 100,000 transactions in every month (i.e., there is no shortfall carried over), the arrangement may be similar to that in Example 7-20, and any overage fees for a particular month would (1) be solely associated with that month and (2) reflect the value of the specific outcome associated with the overage. In that case, C would not be required to estimate the amount of variable consideration to which it would be entitled at contract inception and instead could recognize the variable consideration as the customer’s usage occurs (with the fixed consideration recognized ratably).26

7.5.4 Optional Exemption From Disclosure Requirement

Stakeholders have raised concerns regarding the need to disclose the amount of the transaction price that is allocated to remaining performance obligations when (1) the remaining performance obligations form part of a series, (2) the transaction price includes an amount of variable consideration, and (3) the entity meets the criteria in ASC 606-10-32-40 for allocating the variable amount entirely to a distinct good or service that forms part of a single performance obligation. In these situations, an entity may be required to estimate the amount of variable consideration to include in the transaction price only for disclosure purposes. That is because any remaining variability in the transaction price would be related entirely to unsatisfied portions of a single performance obligation.

ASU 2016-20 includes the addition of an optional exemption to the revenue standard’s guidance on required disclosures. The optional exemption provides relief from the requirement to disclose the amount of variable consideration included in the transaction price that is allocated to outstanding performance obligations when either of the following conditions is met:

The variability is related to a sales- or usage-based royalty.
The variable consideration is allocated entirely to unsatisfied performance obligations or to a wholly unsatisfied promise to transfer a distinct good or service that forms part of a single performance obligation for which the criteria in ASC 606-10-32-40 are met.

Entities electing the optional exemption are still required to disclose any fixed consideration allocated to outstanding performance obligations.

7.5.5 Application of the Variable Consideration Allocation Exception to Commodity Sales Contracts With Market- or Index-Based Pricing

Entities in commodity industries (e.g., oil and gas, power and utilities, mining and metals, and agriculture) may enter into sales contracts to transfer a specified quantity of commodities in exchange for market- or index-based pricing at the time the commodities are transferred.

Commodity sales contracts with market- or index-based pricing contain variable consideration since the ultimate amount to which entities in such contracts are entitled is unknown at contract inception. Consequently, entities that have entered into these contracts should evaluate the criteria in ASC 606-10-32-40 to determine whether the variable consideration allocation exception is met.

Generally, commodity sales contracts that contain only market- or index-based pricing will meet the criteria in ASC 606-10-32-40, and therefore qualify for the variable consideration allocation exception, as follows:

The criterion in ASC 606-10-32-40(a) will generally be met because the variability is solely attributed to, and resolved as a result of, the market- or index-based price upon the transfer of each distinct commodity to the customer.
The criterion in ASC 606-10-32-40(b) will generally be met because the market- or index-based price represents the amount of consideration to which the entity expects to be entitled upon the transfer of each distinct commodity. If the index-based price is unrelated to the commodity (e.g., oil indexed to inflation), the criterion in ASC 606-10-32-40(b) may not be met.

However, when commodity sales contracts with market- or index-based pricing also include fixed consideration or other types of variable consideration, entities will need to consider all of the payment terms to determine whether both of the criteria in ASC 606-10-32-40 are met.

Example 7-25

Company T enters into a contract with a customer to sell and deliver specified gallons of heating oil each day over a two-year period. The price of the heating oil is based on the New York Harbor No. 2 Heating Oil Spot Price (the “Pricing Index”) on the day that the heating oil is delivered to the customer.

Company T concludes that each gallon of heating oil represents a separate performance obligation (i.e., a distinct good). That is, each gallon of heating oil is separately identifiable and capable of benefiting the customer on its own. In addition, control of each gallon of heating oil is transferred at the time of delivery (i.e., at a point in time).

Because of the variable consideration in the contract that arises from the Pricing Index, T evaluates whether the contract meets the criteria in ASC 606-10-32-40 and therefore qualifies for the variable consideration allocation exception. In its evaluation, T makes the following determinations:

The criterion in ASC 606-10-32-40(a) is met because the daily Pricing Index (i.e., the variable consideration) is specifically related to T’s efforts to transfer the distinct goods each day (i.e., each daily quantity of heating oil).
The criterion in ASC 606-10-32-40(b) is met because the Pricing Index reflects the amount of consideration to which T expects to be entitled upon the transfer of the distinct goods (i.e., each daily quantity of heating oil).

On the basis of these determinations, T concludes that it is appropriate to recognize revenue in an amount equal to the gallons of heating oil each day multiplied by the Pricing Index on the day the oil is delivered to the customer.

7.5.6 Accounting for Sponsorship Arrangements

Companies often enter into multiyear sponsorship arrangements with venues (e.g., sports stadiums) to promote their brand. For example, a beer company may enter into a contract with a football stadium to display its logo on the football field. Other examples of sponsorship arrangements include companies’ obtaining the naming rights to stadiums.

Many sponsorship arrangements are relatively long-term (e.g., five years or longer) and may contain stated price increases on an annual basis (e.g., 3 percent increase in the annual fee each year of the contract). The example below illustrates these concepts.

Example 7-26

Chi Corp. owns an arena, which is used by a baseball team, the Streeterville Sluggers, to play its home games from April to October each year. In addition to baseball games, the arena holds other live events (e.g., concerts) that occur evenly throughout the year. The Streeterville Sluggers games constitute approximately 40 percent of the total live events held at the arena throughout the year. The number of other live events is subject to the duration of the team’s season (e.g., the team’s season will be longer if the team makes it into the playoffs).

On January 1, 20X8, Chi Corp. enters into a five-year noncancelable sponsorship agreement with Beer Inc., which allows Beer Inc.’s logo to be displayed throughout the arena. Chi Corp.’s promise to provide the sponsorship rights meets the criteria in ASC 606-10-25-27 to be satisfied over time.

Chi Corp. has concluded that the contract to provide sponsorship rights to Beer Inc. does not contain a lease under ASC 842.

In exchange for the sponsorship rights granted to Beer Inc., Beer Inc. agrees to pay Chi Corp. a fixed fee that increases by 5 percent each year as follows:

Year 1: $1,000,000
Year 2: $1,050,000
Year 3: $1,102,500
Year 4: $1,157,625
Year 5: $1,215,506

Chi Corp. has concluded that the annual fees stated in the contract are equal to the stand-alone selling price of the services provided in each annual period of the sponsorship. In addition, Chi Corp. has concluded that it does not meet the conditions in ASC 606-10-55-18 to apply the invoice practical expedient (see Section 8.5.8.1 for further discussion of the invoice practical expedient).

When assessing how to allocate the annual fees and recognize revenue, Chi Corp. must first evaluate the criteria in ASC 606-10-25-14(b) and 25-15 to determine whether the annual sponsorship rights it promised in a long-term sponsorship arrangement represent a series of distinct licenses (and therefore a single performance obligation) or multiple performance obligations (i.e., separate performance obligations for each annual period).

ASC 606-10-25-14(b) states that a series consists of “distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer.” Further, ASC 606-10-25-15 provides the following two criteria that, if met, would establish that a series of distinct goods or services has the same pattern of transfer to the customer:

“Each distinct good or service in the series that the entity promises to transfer to the customer would meet the criteria in paragraph 606-10-25-27 to be a performance obligation satisfied over time.”
The “same method would be used to measure the entity’s progress toward complete satisfaction of the performance obligation to transfer each distinct good or service in the series to the customer.”

When assessing the criteria in ASC 606-10-25-14(b) and 25-15, Chi Corp. should evaluate the nature of its promise in the sponsorship arrangement and, more specifically, should consider whether the nature of its promise varies throughout the contract term (i.e., whether the promise in one annual period is substantially the same as the promise in other annual periods of the contract term).

If Chi Corp. concludes that the nature of its promise in the sponsorship arrangement is substantially the same in each year of the contract, the promise to provide sponsorship rights over the contract term would meet the criteria in ASC 606-10-25-14(b) and 25-15 to be accounted for as a series of distinct licenses, which are accounted for as a single performance obligation. Although the single performance obligation would consist of a series of distinct licenses, Chi Corp. concludes that it does not meet the criteria in ASC 606-10-32-40 to allocate consideration entirely to one or more, but not all, of the distinct periods within the series because no element of variable consideration exists. Therefore, Chi Corp. would recognize the transaction price (i.e., $5,525,631) by using a single measure of progress over the five-year contract term (e.g., ratably if Chi Corp. determines that time is an appropriate measure of progress). Recognizing revenue by using a time-based measure of progress would result in the creation of a contract asset in year 1, which would increase in years 2 and 3 of the contract and subsequently reverse in years 4 and 5 of the contract.

If, on the other hand, Chi Corp. concludes that the nature of its promise in the sponsorship arrangement is not substantially the same in each year of the contract, the promise to provide sponsorship rights over the contract term would not meet the criteria in ASC 606-10-25-14(b) and 25-15 to be accounted for as a series of distinct licenses. Rather, the contract would consist of five distinct performance obligations since the events occur evenly throughout the year (i.e., a distinct performance obligation for each annual period of the contract). Because the annual fees stated in the contract are equal to the stand-alone selling price of the services provided in each annual period of the sponsorship, Chi Corp. would allocate the stated annual fees in the contract to each annual period. Consequently, Chi Corp. would recognize revenue for each annual period equal to the amount billed to Beer Inc. for that period.

Footnotes

In this section, it is assumed that a SaaS arrangement is accounted for as a service contract because the customer does not have the ability to take possession of the underlying software license on an on-premise basis.

In accordance with ASC 606-10-32-11, variable consideration can only be included in the transaction price “to the extent that it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is subsequently resolved.”

When a sales- or usage-based royalty is related to only a license of IP or to a license of IP that is the predominant item in an arrangement, the royalty is recognized at the later of the date on which (1) the subsequent sale or usage occurs or (2) the performance obligation associated with the royalty is satisfied (or partially satisfied).

This assumes that the invoice practical expedient is not used. However, as discussed in Section 7.5.3.1.1, the invoice practical expedient could be used when a stand-ready SaaS arrangement (1) has a pricing structure that is solely variable on the basis of the customer’s SaaS usage, (2) is priced at a fixed rate per usage, and (3) gives the entity the right to invoice the customer for its usage as the usage occurs.

Since the ratable recognition of variable consideration might result in a contract asset, C should ensure that no separate buying decisions or optional purchases are giving rise to that variability so that it has enforceable rights to such consideration.

However, as discussed in Section 7.5.3.1.1, the invoice practical expedient could be used when a stand-ready SaaS arrangement (1) has a pricing structure that is solely variable on the basis of the customer’s SaaS usage, (2) is priced at a fixed rate per usage, and (3) gives the entity the right to invoice the customer for its usage as the usage occurs. While, in this example, the fees are not solely variable, if (1) the customer is expected to significantly exceed the minimum usage requirements, (2) the minimum usage is priced at the same rate as any overages, and (3) C has the right to invoice the customer for its usage as the usage occurs, C may be able to use the invoice practical expedient (which would result in the recognition of both the fixed and variable fees as usage occurs rather than ratable recognition).

See footnote 10.

$1.2 million fixed consideration plus $100,000 estimated variable consideration.

$1.2 million fixed consideration plus $120,000 estimated variable consideration.

$1.2 million fixed consideration plus $150,000 estimated variable consideration.

To determine whether the invoice practical expedient can be used, see footnote 11.

$100,000 plus ($10,000 × 11 months).

$100,000 + $110,000 + $120,000 + $130,000 + $140,000 + $150,000 + $160,000 + $170,000 + $180,000 + $190,000 + $200,000 + $210,000.

$200,000 total fees (200,000 transactions × $1 per transaction) less $100,000 minimum in month 1.

$200,000 total fees (200,000 transactions × $1 per transaction) less $110,000 minimum in month 2.

$155,000 fixed consideration plus $100,000 overage fees (see footnote 19).

$155,000 fixed consideration plus $90,000 overage fees (see footnote 20).

See footnote 10.

To determine whether the invoice practical expedient can be used, see footnote 11.

Confidential and Proprietary — for Use Solely by Authorized Personnel

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.