Chapter 8 — Step 5: Determine When to Recognize Revenue

8.4 Revenue Recognized Over Time

ASC 606-10

25-27 An entity transfers control of a good or service over time and, therefore, satisfies a performance obligation and recognizes revenue over time, if one of the following criteria is met:

The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs (see paragraphs 606-10-55-5 through 55-6).
The entity’s performance creates or enhances an asset (for example, work in process) that the customer controls as the asset is created or enhanced (see paragraph 606-10-55-7).
The entity’s performance does not create an asset with an alternative use to the entity (see paragraph 606-10-25-28), and the entity has an enforceable right to payment for performance completed to date (see paragraph 606-10-25-29).

ASC 606-10-25-27 is one of the most critical paragraphs in the standard since it effectively defines whether the entity is (1) providing the customer with a service (and revenue should be recognized as the entity is performing) or (2) providing the customer with a good (and revenue should be recognized only when the entity finishes what it was obligated to do and the good is transferred or delivered to the customer).

The criteria in ASC 606-10-25-27 were developed to provide an objective basis for assessing whether control is transferred over time and, therefore, the performance obligation is satisfied over time. The flowchart below summarizes the criteria in ASC 606-10-25-27.

8.4.1 Meeting More Than One of the Criteria for Recognition of Revenue Over Time

The criteria in ASC 606-10-25-27 are not intended to be mutually exclusive, and it is possible that an entity will meet more than one criterion. For example, in some cases it may be determined that the “entity’s performance creates or enhances an asset . . . that the customer controls as the asset is created or enhanced” (ASC 606-10-25-27(b)) and that the entity also “does not create an asset with an alternative use to the entity [and] has an enforceable right to payment for performance completed to date” (ASC 606-10-25-27(c)).

When one or more of the criteria in ASC 606-10-25-27 are met, revenue should be recognized over time.

8.4.2 Application of ASC 606-10-25-27 to Contracts With a Very Short Duration

For contracts with a short duration (e.g., a one-year contract or a one-month contract), ASC 606 does not contain any practical expedient under which entities would not be required to assess whether revenue should be recognized over time or at a point in time but rather would simply default to point-in-time recognition.

Entities should carefully analyze the contractual arrangement in accordance with the requirements of ASC 606-10-25-27 to determine whether the performance obligation is satisfied over time or at a point in time, even for short-duration contracts. Depending on the timing of the transfer of control, the distinction could result in different accounting outcomes when control is transferred in multiple reporting periods. In addition, entities should consider the different disclosure requirements related to those performance obligations that are satisfied over time versus those that are satisfied at a point in time.

8.4.3 Simultaneous Receipt and Consumption of Benefits of the Entity’s Performance

ASC 606-10

25-27 An entity transfers control of a good or service over time and, therefore, satisfies a performance obligation and recognizes revenue over time, if one of the following criteria is met:

The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs (see paragraphs 606-10-55-5 through 55-6). . . .

55-5 For some types of performance obligations, the assessment of whether a customer receives the benefits of an entity’s performance as the entity performs and simultaneously consumes those benefits as they are received will be straightforward. Examples include routine or recurring services (such as a cleaning service) in which the receipt and simultaneous consumption by the customer of the benefits of the entity’s performance can be readily identified.

55-6 For other types of performance obligations, an entity may not be able to readily identify whether a customer simultaneously receives and consumes the benefits from the entity’s performance as the entity performs. In those circumstances, a performance obligation is satisfied over time if an entity determines that another entity would not need to substantially reperform the work that the entity has completed to date if that other entity were to fulfill the remaining performance obligation to the customer. In determining whether another entity would not need to substantially reperform the work the entity has completed to date, an entity should make both of the following assumptions:

Disregard potential contractual restrictions or practical limitations that otherwise would prevent the entity from transferring the remaining performance obligation to another entity
Presume that another entity fulfilling the remainder of the performance obligation would not have the benefit of any asset that is presently controlled by the entity and that would remain controlled by the entity if the performance obligation were to transfer to another entity.

The first criterion for determining whether a performance obligation is satisfied over time (ASC 606-10- 25-27(a)) is that a customer simultaneously receives and consumes benefits as the entity performs. This criterion most commonly applies to typical service contracts, which would generally meet the criterion. That is, the entity’s performance momentarily creates an asset that the customer simultaneously receives and consumes, which means that the customer obtains control of the entity’s output as the entity performs. Typically, in contracts that meet the criterion in ASC 606-10-25-27(a), there is no tangible asset that is being created by the accumulation of effort of the entity as it performs. For example, a contract to provide a cleaning service and a contract to process transactions on behalf of a customer are arrangements in which the customer simultaneously consumes as the entity performs. That is, in each of those examples, there is no accumulation of the entity’s efforts to build or create an asset (e.g., a report, completed building, or piece of specialized equipment). However, the customer does benefit from the entity’s efforts as the entity performs; therefore, control of an asset is transferred to the customer over time.

The FASB and IASB observed that determining whether the customer simultaneously receives and consumes may be difficult in service-type contracts because the notion of “benefit” can be subjective. Paragraph BC126 of ASU 2014-09 provides a shipping example in which an entity has agreed to transport goods from Vancouver to New York City. Stakeholders questioned whether the customer in that example receives any benefit as the goods are transported. ASC 606-10-55-6 notes that an entity’s customer receives benefit as the entity performs if another entity would not need to substantially reperform the work that the entity has completed to date to fulfill the remaining performance obligation.

ASC 606-10-55-6(b) clarifies that when assessing whether another entity would not need to substantially reperform the work completed to date, an entity should presume that the other entity would not be able to use the asset being used by the current entity to fulfill the performance obligation. The boards observed that if the goods in the shipping example described above were to be transported only part of the way (e.g., to Chicago), another entity would not need to substantially reperform what has already been performed even though that other entity does not have the benefit of using the original entity’s truck to transport the goods. Therefore, even though the new entity would need to use its own truck to complete the fulfillment of the performance obligation, the customer does in fact benefit from the original entity’s performance as the work is performed (i.e., transfer of the goods from Vancouver to Chicago). Consequently, the boards observed that assessing whether another entity would need to substantially reperform the performance completed to date can be a good indicator of whether the customer benefits simultaneously as the entity performs. However, the boards also decided that in making this assessment, an entity should disregard any contractual or practical limitations since the objective of the criterion in ASC 606-10-25-27(a) is to determine whether control of the goods or services has already been transferred to the customer. That is, the entity would need to hypothetically assess what another entity would need to reperform the work if the original entity were to stop performance and let the second entity take over, regardless of actual practical or contractual limitations. This hypothetical assessment would only be applicable when the customer simultaneously receives and consumes as the entity performs; such an assessment would not be appropriate for scenarios that meet either of the other two criteria in ASC 606-10-25-27, which are discussed further below.

ASC 606-10

Example 13 — Customer Simultaneously Receives and Consumes the Benefits

55-159 An entity enters into a contract to provide monthly payroll processing services to a customer for one year.

55-160 The promised payroll processing services are accounted for as a single performance obligation in accordance with paragraph 606-10-25-14(b). The performance obligation is satisfied over time in accordance with paragraph 606-10-25-27(a) because the customer simultaneously receives and consumes the benefits of the entity’s performance in processing each payroll transaction as and when each transaction is processed. The fact that another entity would not need to reperform payroll processing services for the service that the entity has provided to date also demonstrates that the customer simultaneously receives and consumes the benefits of the entity’s performance as the entity performs. (The entity disregards any practical limitations on transferring the remaining performance obligation, including setup activities that would need to be undertaken by another entity.) The entity recognizes revenue over time by measuring its progress toward complete satisfaction of that performance obligation in accordance with paragraphs 606-10-25-31 through 25-37 and 606-10-55-16 through 55-21.

Connecting the Dots

Stakeholders have raised questions regarding the determination of when an entity transfers control of a commodity. Specifically, they have questioned whether revenue related to the delivery of a commodity should be recognized (1) at a point in time for each commodity delivery or (2) over time because the entity is providing a commodity delivery service of which the customer simultaneously receives and consumes the benefits. In particular, the analysis in question has focused on ASC 606-10-25-27(a), one of the three criteria for determining whether revenue should be recognized over time.

For the criterion in ASC 606-10-25-27(a) to be met, the customer must simultaneously receive and consume the benefits of the good or service (e.g., the commodity) as the entity performs. The FASB staff discusses this issue in Implementation Q&A 50 (compiled from TRG Agenda Papers 43 and 44), noting that the evaluation of the criterion in ASC 606-10-25-27(a) should take into consideration “all relevant facts and circumstances, including the inherent characteristics of the commodity, the contract terms, and information about infrastructure or other delivery mechanisms.” In Implementation Q&A 50, the FASB staff further notes that the evaluation should be performed in this manner “regardless of whether the contract is for the delivery of a commodity or a widget.”

Accounting outcomes may differ if a multiperiod commodity supply contract is viewed as individually distinct goods or services (i.e., each individual delivery is a performance obligation satisfied at a point in time) or as a series of distinct goods or services of which the customer simultaneously receives and consumes the benefits (i.e., delivery is part of a single performance obligation satisfied over time). If the contract is determined to be for the delivery of individually distinct goods or services (that do not qualify to be accounted for as a series), the entity would need to allocate the transaction price to each distinct good or service on a relative stand-alone selling price basis. If the goods or services in the contract are determined to be a series (i.e., a single performance obligation satisfied over time), the entity would need to identify a single measure of progress to determine the pattern of revenue recognition.

An entity may need to evaluate whether the customer’s action or intent to immediately receive and consume a commodity or use the commodity later will affect whether the entity is able to conclude that it meets the criteria for recognizing revenue over time (i.e., by meeting the criterion that the “customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs”). Customers in certain industries (e.g., oil and gas, power and utilities) may take different actions or have different intents for the commodity delivered by the entity.

For example, a gas utility customer of an entity that explores for and produces natural gas may store natural gas in a pool until demand from its own customers requires the natural gas to be used. Conversely, those same customers of the gas utility may not have infrastructure with which to store natural gas in their homes and thereby immediately receive and consume any natural gas delivered by the utility (e.g., to heat a stove).

8.4.4 Customer Controls the Asset as It Is Created or Enhanced

ASC 606-10

25-27 An entity transfers control of a good or service over time and, therefore, satisfies a performance obligation and recognizes revenue over time, if one of the following criteria is met: . . .

b. The entity’s performance creates or enhances an asset (for example, work in process) that the customer controls as the asset is created or enhanced (see paragraph 606-10-55-7). . . .

55-7 In determining whether a customer controls an asset as it is created or enhanced in accordance with paragraph 606-10-25-27(b), an entity should apply the guidance on control in paragraphs 606-10-25-23 through 25-26 and 606-10-25-30. The asset that is being created or enhanced (for example, a work in process asset) could be either tangible or intangible.

The second criterion for determining whether a performance obligation is satisfied over time (ASC 606-10-25-27(b)) is that the entity’s performance creates or enhances an asset that the customer controls as the asset is created or enhanced. This criterion was intended to address situations in which the entity is creating an asset but it is clear that the customer controls the work in process as the asset is created. Arrangements that would meet this criterion for recognizing revenue over time include, but are not limited to, (1) a renovation of, or addition to, the customer’s existing property and (2) the configuration or customization of computer hardware and software owned by the customer. Because the customer controls the work in process, the customer is benefiting from the entity’s performance as the entity performs.

Example 8-1

Entity B enters into a contract to manufacture a customized part for Customer L. To manufacture the part, B must purchase the raw materials from the supplier designated by L (i.e., B does not have discretion to select the supplier). Entity B places orders directly with the supplier, and it accepts and takes legal title to the raw materials directly from the supplier. The acceptability of the raw materials and work in process is B’s responsibility, and the raw materials and work in process stay in B’s physical possession throughout the manufacturing process. Title to the part, as well as the significant risks and rewards of ownership of the part, is transferred to L upon shipment of the part to L. The part is customized to L’s specifications and has no alternative use to B. However, B does not have an enforceable right to payment and therefore fails to meet the criterion in ASC 606-10-25-27(c).

Entity B’s contract with L also does not meet the criterion in ASC 606-10-25-27(b) for recognizing revenue over time, as supported by the following:

Customer L does not accept, physically possess, or have title to the raw materials or work in process because B is manufacturing the customized part.
Entity B has the risks and rewards of ownership of the raw materials and work in process until title to, and the risks and rewards of ownership of, the finished part are transferred to L.
Although L has discretion in selecting the supplier for the raw materials, this does not give L control over the raw materials or the subsequent work in process.

The basis for the second criterion that the entity has in effect agreed to sell its right to the asset as it performs (i.e., it is selling the work in process to the customer as it performs).

However, in some instances, it may be unclear whether the asset being created or enhanced is controlled by the customer, thus making it more difficult to determine whether this criterion is met. Therefore, the boards developed the third criterion.

8.4.5 Entity’s Performance Does Not Create an Asset With an Alternative Use, and the Entity Has an Enforceable Right to Payment

ASC 606-10

25-27 An entity transfers control of a good or service over time and, therefore, satisfies a performance obligation and recognizes revenue over time, if one of the following criteria is met: . . .

c. The entity’s performance does not create an asset with an alternative use to the entity (see paragraph 606-10-25-28), and the entity has an enforceable right to payment for performance completed to date (see paragraph 606-10-25-29).

The third criterion (ASC 606-10-25-27(c)) was developed because the FASB and IASB observed that applying the first two criteria could sometimes be challenging. In addition, the boards believed that there are other scenarios economically similar to those described in ASC 606-10-25-27(a) and (b) in which an entity’s performance is more akin to a service than the completion and delivery of a good. Paragraph BC132 of ASU 2014-09 states that the boards regarded the third criterion as potentially necessary not only “for services that may be specific to a customer (for example, consulting services that ultimately result in a professional opinion for the customer) but also for the creation of tangible (or intangible) goods.”

The boards believed that there are two mandatory features of arrangements that meet this criterion. As a result, this criterion involves a two-part assessment (i.e., to meet the criterion, an entity must demonstrate compliance with two subcriteria), which includes two notions: “alternative use” and “right to payment.”

8.4.5.1 Alternative Use

ASC 606-10

25-28 An asset created by an entity’s performance does not have an alternative use to an entity if the entity is either restricted contractually from readily directing the asset for another use during the creation or enhancement of that asset or limited practically from readily directing the asset in its completed state for another use. The assessment of whether an asset has an alternative use to the entity is made at contract inception. After contract inception, an entity shall not update the assessment of the alternative use of an asset unless the parties to the contract approve a contract modification that substantively changes the performance obligation. Paragraphs 606-10-55-8 through 55-10 provide guidance for assessing whether an asset has an alternative use to an entity.

55-8 In assessing whether an asset has an alternative use to an entity in accordance with paragraph 606-10- 25-28, an entity should consider the effects of contractual restrictions and practical limitations on the entity’s ability to readily direct that asset for another use, such as selling it to a different customer. The possibility of the contract with the customer being terminated is not a relevant consideration in assessing whether the entity would be able to readily direct the asset for another use.

55-9 A contractual restriction on an entity’s ability to direct an asset for another use must be substantive for the asset not to have an alternative use to the entity. A contractual restriction is substantive if a customer could enforce its rights to the promised asset if the entity sought to direct the asset for another use. In contrast, a contractual restriction is not substantive if, for example, an asset is largely interchangeable with other assets that the entity could transfer to another customer without breaching the contract and without incurring significant costs that otherwise would not have been incurred in relation to that contract.

55-10 A practical limitation on an entity’s ability to direct an asset for another use exists if an entity would incur significant economic losses to direct the asset for another use. A significant economic loss could arise because the entity either would incur significant costs to rework the asset or would only be able to sell the asset at a significant loss. For example, an entity may be practically limited from redirecting assets that either have design specifications that are unique to a customer or are located in remote areas.

The notion of alternative use was developed to distinguish circumstances in which the entity’s performance does not represent a service and therefore would not result in the transfer of control to the customer over time. That is, if the asset has an alternative use, the asset could readily be redirected to another customer, which is commonly the case for standard inventory-type items. In the case of inventory (readily redirected assets), the production effort is not transferring a benefit to the customer as the entity performs. The criterion in ASC 606-10-25-27(c) was intended to apply to circumstances in which the entity creates a highly customized or specialized asset that would be difficult to redirect to another customer without incurring significant costs and performing additional work.

In making this assessment, the entity needs to consider both practical limitations and contractual restrictions on redirecting the asset for another use. For example, if the terms of the contract indicate that the entity is prohibited from transferring the asset to another customer and that restriction is substantive, the entity would conclude that the asset does not have an alternative use because the entity is contractually prohibited from redirecting the asset for another use. This is often the case in real estate contracts; however, it may also occur in other types of contracts, such as those involving the construction of highly specialized assets.

On the other hand, contractual restrictions that provide the customer with a protective right are not sufficient to establish that there is no alternative use for the asset. Protective rights typically allow the entity to substitute the asset, or redirect the asset, without the customer’s knowledge. For example, terms of the contract may indicate that the entity cannot transfer a good because the customer has legal title to the goods in the contract; however, these terms may act merely as protection in the event of liquidation, and the entity can then physically substitute the asset or redirect it to another customer for little cost. This type of contractual restriction is a protective right and would not be viewed as transferring control to the customer.

An entity’s assessment of alternative use should be performed at contract inception and should not be updated unless there is a contract modification that substantively changes the performance obligation. In performing the assessment, the entity should consider the asset in its completed state when determining whether the asset can practically be readily redirected. Further, in addition to concluding that there is no alternative use, the entity must conclude that it has a right to payment for performance completed to date, which is further described in Section 8.4.5.2.

ASC 606-10

Example 15 — Asset Has No Alternative Use to the Entity

55-165 An entity enters into a contract with a customer, a government agency, to build a specialized satellite. The entity builds satellites for various customers, such as governments and commercial entities. The design and construction of each satellite differ substantially, on the basis of each customer’s needs and the type of technology that is incorporated into the satellite.

55-166 At contract inception, the entity assesses whether its performance obligation to build the satellite is a performance obligation satisfied over time in accordance with paragraph 606-10-25-27.

55-167 As part of that assessment, the entity considers whether the satellite in its completed state will have an alternative use to the entity. Although the contract does not preclude the entity from directing the completed satellite to another customer, the entity would incur significant costs to rework the design and function of the satellite to direct that asset to another customer. Consequently, the asset has no alternative use to the entity (see paragraphs 606-10-25-27(c), 606-10-25-28, and 606-10-55-8 through 55-10) because the customer-specific design of the satellite limits the entity’s practical ability to readily direct the satellite to another customer.

55-168 For the entity’s performance obligation to be satisfied over time when building the satellite, paragraph 606-10-25-27(c) also requires the entity to have an enforceable right to payment for performance completed to date. This condition is not illustrated in this Example.

Example 8-2

A manufacturer of automobile parts enters into a contract with a customer for the initial production of 1,000 parts for the customer’s new vehicle. The parts are highly customized and only compatible with the customer’s new vehicle (i.e., the parts would not function in other vehicles). The contract provides the manufacturer with an enforceable right to payment for its performance throughout the contract period in accordance with ASC 606-10-25-27(c). There are no contractual restrictions preventing the manufacturer from redirecting the finished parts to a third party. However, since an aftermarket for the parts does not exist at contract inception and there are no other customers to which the part can be readily directed, the manufacturer is limited practically from redirecting the parts for another use.

In this example, the contract for the initial production of parts meets the criterion in ASC 606-10-25-27(c) for recognizing revenue over time. In accordance with ASC 606-10-25-27(c), an entity is required to recognize revenue over time if the asset being produced has no alternative use and the entity has an enforceable right to payment. ASC 606-10-25-28 further requires an entity to determine “at contract inception” whether the asset being produced has an alternative use. Since the manufacturer in this fact pattern is limited practically from redirecting the parts for another use (because no aftermarket exists at contract inception), the parts do not have an alternative use. Since the parts do not have an alternative use and, as noted above, the contract provides an enforceable right to payment for the manufacturer’s performance throughout the contract period, the criterion in ASC 606-10-25-27(c) would be met. However, once an aftermarket for the parts does exist, the manufacturer would be able to redirect the parts to another party, thereby creating an alternative use. At that point, the criterion in ASC 606-10-25-27(c) for recognizing revenue over time would no longer be met for future contracts to manufacture and deliver the parts (including any modifications to the original contract that substantively change the performance obligation).

We acknowledge that in other situations, a manufacturer of parts may believe that it is highly probable that an aftermarket for the parts will exist in the future (e.g., after the development stage). In these situations, entities will need to apply judgment and consider all of the relevant facts and circumstances, including, but not limited to, (1) historical evidence, (2) the quantity of the parts, (3) the nature of the parts, (4) the stage of development, (5) the existence of a contract, and (6) contract negotiations. Entities may want to consult with their accounting advisers in such situations.

Connecting the Dots

In Implementation Q&A 55 (compiled from TRG Agenda Papers 56 and 60), the FASB staff discusses whether an entity should consider the completed asset or the in-production asset when performing the “alternative use” assessment under ASC 606-10-25-27(c). The FASB staff’s analysis of this issue is illustrated in the following example:

An entity enters into a contract with a customer to build equipment. The entity is in the business of building custom equipment for various customers. The customization of the equipment occurs when the manufacturing process is approximately 75% complete. In other words, for approximately 75% of the manufacturing process, the in-process asset could be redirected to fulfill another customer’s equipment order (assuming there is no contractual restriction to do so). However, the equipment cannot be sold in its completed state to another customer without incurring a significant economic loss. The design specifications of the equipment are unique to the customer and the entity would only be able to sell the completed equipment at a significant loss.

The FASB staff notes in Implementation Q&A 55 that “[b]ecause the entity [in the example] cannot sell the completed equipment to another customer without incurring a significant economic loss, the entity has a practical limitation on its ability to direct the equipment in its completed state and, therefore, the asset does not have an alternative use.” Accordingly, regardless of the timing of the customization in the production process (i.e., when the good has no alternative use), the entity should consider whether the completed asset could be redirected to another customer without the need for significant rework on the customized good. If the completed asset is deemed to have no alternative use, that aspect of the criterion in ASC 606-10-25-27(c) would be met.

8.4.5.2 Enforceable Right to Payment for Performance Completed to Date

ASC 606-10

25-29 An entity shall consider the terms of the contract, as well as any laws that apply to the contract, when evaluating whether it has an enforceable right to payment for performance completed to date in accordance with paragraph 606-10-25-27(c). The right to payment for performance completed to date does not need to be for a fixed amount. However, at all times throughout the duration of the contract, the entity must be entitled to an amount that at least compensates the entity for performance completed to date if the contract is terminated by the customer or another party for reasons other than the entity’s failure to perform as promised. Paragraphs 606-10-55-11 through 55-15 provide guidance for assessing the existence and enforceability of a right to payment and whether an entity’s right to payment would entitle the entity to be paid for its performance completed to date.

55-11 In accordance with paragraph 606-10-25-29, an entity has a right to payment for performance completed to date if the entity would be entitled to an amount that at least compensates the entity for its performance completed to date in the event that the customer or another party terminates the contract for reasons other than the entity’s failure to perform as promised. An amount that would compensate an entity for performance completed to date would be an amount that approximates the selling price of the goods or services transferred to date (for example, recovery of the costs incurred by an entity in satisfying the performance obligation plus a reasonable profit margin) rather than compensation for only the entity’s potential loss of profit if the contract were to be terminated. Compensation for a reasonable profit margin need not equal the profit margin expected if the contract was fulfilled as promised, but an entity should be entitled to compensation for either of the following amounts:

A proportion of the expected profit margin in the contract that reasonably reflects the extent of the entity’s performance under the contract before termination by the customer (or another party)
A reasonable return on the entity’s cost of capital for similar contracts (or the entity’s typical operating margin for similar contracts) if the contract-specific margin is higher than the return the entity usually generates from similar contracts.

55-12 An entity’s right to payment for performance completed to date need not be a present unconditional right to payment. In many cases, an entity will have an unconditional right to payment only at an agreed-upon milestone or upon complete satisfaction of the performance obligation. In assessing whether it has a right to payment for performance completed to date, an entity should consider whether it would have an enforceable right to demand or retain payment for performance completed to date if the contract were to be terminated before completion for reasons other than the entity’s failure to perform as promised.

55-13 In some contracts, a customer may have a right to terminate the contract only at specified times during the life of the contract or the customer might not have any right to terminate the contract. If a customer acts to terminate a contract without having the right to terminate the contract at that time (including when a customer fails to perform its obligations as promised), the contract (or other laws) might entitle the entity to continue to transfer to the customer the goods or services promised in the contract and require the customer to pay the consideration promised in exchange for those goods or services. In those circumstances, an entity has a right to payment for performance completed to date because the entity has a right to continue to perform its obligations in accordance with the contract and to require the customer to perform its obligations (which include paying the promised consideration).

55-14 In assessing the existence and enforceability of a right to payment for performance completed to date, an entity should consider the contractual terms as well as any legislation or legal precedent that could supplement or override those contractual terms. This would include an assessment of whether:

Legislation, administrative practice, or legal precedent confers upon the entity a right to payment for performance to date even though that right is not specified in the contract with the customer.
Relevant legal precedent indicates that similar rights to payment for performance completed to date in similar contracts have no binding legal effect.
An entity’s customary business practices of choosing not to enforce a right to payment has resulted in the right being rendered unenforceable in that legal environment. However, notwithstanding that an entity may choose to waive its right to payment in similar contracts, an entity would continue to have a right to payment to date if, in the contract with the customer, its right to payment for performance to date remains enforceable.

55-15 The payment schedule specified in a contract does not necessarily indicate whether an entity has an enforceable right to payment for performance completed to date. Although the payment schedule in a contract specifies the timing and amount of consideration that is payable by a customer, the payment schedule might not necessarily provide evidence of the entity’s right to payment for performance completed to date. This is because, for example, the contract could specify that the consideration received from the customer is refundable for reasons other than the entity failing to perform as promised in the contract.

Right to payment is the second mandatory feature in the assessment of whether the criterion in ASC 606-10-25-27(c) is met. The boards reasoned that if an entity is creating a highly specialized or customized asset without an alternative use (i.e., the entity meets the first subcriterion in ASC 606-10- 25-27(c)), the entity would want to be economically protected from the risk associated with doing so. Consequently, the boards incorporated the requirement of a right to payment into the third criterion for assessing whether the entity is transferring control of the asset to the customer over time (i.e., providing a service). In addition, the customer’s obligation to pay for performance completed to date indicates that the customer has received some of the benefits of the entity’s performance.

For the purpose of evaluating the guidance in ASC 606-10-25-27(c), the right to payment refers to a payment compensating the entity for performance completed to date and does not pertain to, for example, a deposit or payment to compensate the entity for inconvenience or loss of profit in the event of a termination. The right to payment for performance completed to date must include compensation for costs incurred to date plus a reasonable profit margin. A reasonable profit margin does not necessarily mean the profit margin that the entity would earn on the entire contract once completed (i.e., if the contract were to be terminated at any point in time, the partially completed asset may not be proportional to the value of the contract if it was completed). Rather, a reasonable profit margin should be (1) based on a reasonable proportion of the entity’s expected profit margin or (2) a reasonable return on the entity’s cost of capital.

Further, the right to payment must be an enforceable right to demand or retain payment, or both. However, it does not need to be a present unconditional right to payment in the event that the customer terminates the contract before the asset is fully completed.

If the customer pays a nonrefundable up-front fee, this could be viewed as a right to payment if the entity is able to retain at least an amount for performance completed to date in the event of a contract termination. However, payment terms by themselves do not support a determination of whether an entity has an enforceable right to payment for performance completed to date. Rather, the entity should evaluate whether it has an enforceable right to payment if the contract were to be terminated for reasons other than the entity’s failure to perform. For example, an entity may be paid only upon contract completion or may be paid entirely up front. In those circumstances, the entity must consider whether it has a right to demand or retain payment for performance completed to date if the contract were to be terminated.

The FASB and IASB clarified that there may be instances in which an entity’s customer does not have the right to terminate the contract, or only has the right to terminate the contract at specified times, but the entity may still conclude that it has an enforceable right to payment. Such instances may occur if the contract or other jurisdictional laws require completion of obligations by both the entity and the customer. This is often referred to as the specific performance notion. Refer to Example 8-4 for an illustration of the specific performance notion.

While an entity may conclude that it meets the criterion in ASC 606-10-25-27(c) for recognizing revenue over time because it is creating an asset that does not have an alternative use and it has the right to payment for performance completed to date, recognition of revenue may not be appropriate for materials purchased that are not yet incorporated into the asset. For example, an entity may purchase raw materials that will be used as inputs to satisfy the performance obligation, but the inputs are not yet transferred to the customer through incorporation into the asset and therefore still may be used for other purposes. The example below illustrates this concept.

Example 8-3

Entity X enters into a contract with Customer Y under which X will construct an asset for Y that has no alternative use to X. To build this machine, X acquires standard materials that it regularly uses in other contracts and manufactures some “generic” component parts for inclusion in the customer’s asset. These standard materials remain interchangeable with other items until actually deployed in the construction of the asset for Y.

If Y cancels the contract, X will be entitled to reimbursement for costs incurred for work completed to date plus a margin of 10 percent (which is considered to be a reasonable margin in accordance with ASC 606-10-55-11). However, X will not be reimbursed for any materials (e.g., subcomponent parts) that have been purchased for use in the contract but have not yet been used and are still controlled by X.

Under ASC 606-10-25-27(c), revenue from a contract should be recognized over time if the “entity’s performance does not create an asset with an alternative use to the entity . . . , and the entity has an enforceable right to payment for performance completed to date” (emphasis added).

The asset that X is constructing for Y has no alternative use to X, and the terms of the contract reimburse X for the costs of work completed to date plus a reasonable margin. However, materials (e.g., subcomponent parts that may be classified as inventory) that have not yet been used are not part of “performance completed to date”; therefore, there is no requirement that the entity have an enforceable right to reimbursement for such items.

Under the contract termination provisions, if the customer terminates the contract early, X is entitled to payment of costs incurred plus a reasonable profit margin. However, the contractual terms do not include payment for standard materials or “generic” component parts that were specifically acquired for the project but not yet incorporated into the customized machine.

That is, if the raw materials or work in process has an alternative use before being integrated into the manufacturing process, the raw materials or work in process would not be considered costs of the contract until integrated into the manufacturing process. Consequently, the materials or work in process does not transfer to the customer until (1) integration of the materials or work in process into the project and (2) the entity has an enforceable right to payment.

Therefore, the absence of a right to payment for raw materials or work in process that has an alternative use does not preclude an entity from being able to conclude that a performance obligation is satisfied over time when the entity has an enforceable right to payment for performance completed to date once the entity has integrated the raw materials or work in process into the project. Accordingly, X’s contract with Y meets the condition in ASC 606-10-25-27(c) for recognition of revenue over time.

Connecting the Dots

An entity that has entered into a contract to manufacture customized goods may conclude that the goods have no alternative use. In addition, depending on the payment terms of the contract for customized goods, the entity may be required to recognize revenue over time. In this arrangement, the entity will need to carefully consider the contract’s payment terms to determine the appropriate recognition of revenue. Specifically, the entity may need to consider termination provisions in the arrangement and how they interact with the entity’s right to payment. For example, if the entity has some rights to payment for its performance, but the contract has a termination provision that allows the customer to cancel at any time with no obligation to pay the entity for work performed under the contract, the entity may not meet the criteria for recognizing revenue over time because it has not met the right to payment requirement.

ASC 606-10

Example 14 — Assessing Alternative Use and Right to Payment

55-161 An entity enters into a contract with a customer to provide a consulting service that results in the entity providing a professional opinion to the customer. The professional opinion relates to facts and circumstances that are specific to the customer. If the customer were to terminate the consulting contract for reasons other than the entity’s failure to perform as promised, the contract requires the customer to compensate the entity for its costs incurred plus a 15 percent margin. The 15 percent margin approximates the profit margin that the entity earns from similar contracts.

55-162 The entity considers the criterion in paragraph 606-10-25-27(a) and the guidance in paragraphs 606-10-55-5 through 55-6 to determine whether the customer simultaneously receives and consumes the benefits of the entity’s performance. If the entity were to be unable to satisfy its obligation and the customer hired another consulting firm to provide the opinion, the other consulting firm would need to substantially reperform the work that the entity had completed to date because the other consulting firm would not have the benefit of any work in progress performed by the entity. The nature of the professional opinion is such that the customer will receive the benefits of the entity’s performance only when the customer receives the professional opinion. Consequently, the entity concludes that the criterion in paragraph 606-10-25-27(a) is not met.

55-163 However, the entity’s performance obligation meets the criterion in paragraph 606-10-25-27(c) and is a performance obligation satisfied over time because of both of the following factors:

In accordance with paragraphs 606-10-25-28 and 606-10-55-8 through 55-10, the development of the professional opinion does not create an asset with alternative use to the entity because the professional opinion relates to facts and circumstances that are specific to the customer. Therefore, there is a practical limitation on the entity’s ability to readily direct the asset to another customer.
In accordance with paragraphs 606-10-25-29 and 606-10-55-11 through 55-15, the entity has an enforceable right to payment for its performance completed to date for its costs plus a reasonable margin, which approximates the profit margin in other contracts.

55-164 Consequently, the entity recognizes revenue over time by measuring the progress toward complete satisfaction of the performance obligation in accordance with paragraphs 606-10-25-31 through 25-37 and 606-10-55-16 through 55-21.

Example 16 — Enforceable Right to Payment for Performance Completed to Date

55-169 An entity enters into a contract with a customer to build an item of equipment. The payment schedule in the contract specifies that the customer must make an advance payment at contract inception of 10 percent of the contract price, regular payments throughout the construction period (amounting to 50 percent of the contract price), and a final payment of 40 percent of the contract price after construction is completed and the equipment has passed the prescribed performance tests. The payments are nonrefundable unless the entity fails to perform as promised. If the customer terminates the contract, the entity is entitled only to retain any progress payments received from the customer. The entity has no further rights to compensation from the customer.

55-170 At contract inception, the entity assesses whether its performance obligation to build the equipment is a performance obligation satisfied over time in accordance with paragraph 606-10-25-27.

55-171 As part of that assessment, the entity considers whether it has an enforceable right to payment for performance completed to date in accordance with paragraphs 606-10-25-27(c), 606-10-25-29, and 606-10- 55-11 through 55-15 if the customer were to terminate the contract for reasons other than the entity’s failure to perform as promised. Even though the payments made by the customer are nonrefundable, the cumulative amount of those payments is not expected, at all times throughout the contract, to at least correspond to the amount that would be necessary to compensate the entity for performance completed to date. This is because at various times during construction the cumulative amount of consideration paid by the customer might be less than the selling price of the partially completed item of equipment at that time. Consequently, the entity does not have a right to payment for performance completed to date.

55-172 Because the entity does not have a right to payment for performance completed to date, the entity’s performance obligation is not satisfied over time in accordance with paragraph 606-10-25-27(c). Accordingly, the entity does not need to assess whether the equipment would have an alternative use to the entity. The entity also concludes that it does not meet the criteria in paragraph 606-10-25-27(a) or (b), and, thus, the entity accounts for the construction of the equipment as a performance obligation satisfied at a point in time in accordance with paragraph 606-10-25-30.

Example 17 — Assessing Whether a Performance Obligation Is Satisfied at a Point in Time or Over Time

55-173 An entity is developing a multi-unit residential complex. A customer enters into a binding sales contract with the entity for a specified unit that is under construction. Each unit has a similar floor plan and is of a similar size, but other attributes of the units are different (for example, the location of the unit within the complex).

Case A — Entity Does Not Have an Enforceable Right to Payment for Performance Completed to Date

55-174 The customer pays a deposit upon entering into the contract, and the deposit is refundable only if the entity fails to complete construction of the unit in accordance with the contract. The remainder of the contract price is payable on completion of the contract when the customer obtains physical possession of the unit. If the customer defaults on the contract before completion of the unit, the entity only has the right to retain the deposit.

55-175 At contract inception, the entity applies paragraph 606-10-25-27(c) to determine whether its promise to construct and transfer the unit to the customer is a performance obligation satisfied over time. The entity determines that it does not have an enforceable right to payment for performance completed to date because until construction of the unit is complete, the entity only has a right to the deposit paid by the customer. Because the entity does not have a right to payment for work completed to date, the entity’s performance obligation is not a performance obligation satisfied over time in accordance with paragraph 606-10-25-27(c). Instead, the entity accounts for the sale of the unit as a performance obligation satisfied at a point in time in accordance with paragraph 606-10-25-30.

Case B — Entity Has an Enforceable Right to Payment for Performance Completed to Date

55-176 The customer pays a nonrefundable deposit upon entering into the contract and will make progress payments during construction of the unit. The contract has substantive terms that preclude the entity from being able to direct the unit to another customer. In addition, the customer does not have the right to terminate the contract unless the entity fails to perform as promised. If the customer defaults on its obligations by failing to make the promised progress payments as and when they are due, the entity would have a right to all of the consideration promised in the contract if it completes the construction of the unit. The courts have previously upheld similar rights that entitle developers to require the customer to perform, subject to the entity meeting its obligations under the contract.

55-177 At contract inception, the entity applies paragraph 606-10-25-27(c) to determine whether its promise to construct and transfer the unit to the customer is a performance obligation satisfied over time. The entity determines that the asset (unit) created by the entity’s performance does not have an alternative use to the entity because the contract precludes the entity from transferring the specified unit to another customer. The entity does not consider the possibility of a contract termination in assessing whether the entity is able to direct the asset to another customer.

55-178 The entity also has a right to payment for performance completed to date in accordance with paragraphs 606-10-25-29 and 606-10-55-11 through 55-15. This is because if the customer were to default on its obligations, the entity would have an enforceable right to all of the consideration promised under the contract if it continues to perform as promised.

55-179 Therefore, the terms of the contract and the practices in the legal jurisdiction indicate that there is a right to payment for performance completed to date. Consequently, the criteria in paragraph 606-10-25-27(c) are met, and the entity has a performance obligation that it satisfies over time. To recognize revenue for that performance obligation satisfied over time, the entity measures its progress toward complete satisfaction of its performance obligation in accordance with paragraphs 606-10-25-31 through 25-37 and 606-10-55-16 through 55-21.

55-180 In the construction of a multi-unit residential complex, the entity may have many contracts with individual customers for the construction of individual units within the complex. The entity would account for each contract separately. However, depending on the nature of the construction, the entity’s performance in undertaking the initial construction works (that is, the foundation and the basic structure), as well as the construction of common areas, may need to be reflected when measuring its progress toward complete satisfaction of its performance obligations in each contract.

Case C — Entity Has an Enforceable Right to Payment for Performance Completed to Date

55-181 The same facts as in Case B apply to Case C, except that in the event of a default by the customer, either the entity can require the customer to perform as required under the contract or the entity can cancel the contract in exchange for the asset under construction and an entitlement to a penalty of a proportion of the contract price.

55-182 Notwithstanding that the entity could cancel the contract (in which case the customer’s obligation to the entity would be limited to transferring control of the partially completed asset to the entity and paying the penalty prescribed), the entity has a right to payment for performance completed to date because the entity also could choose to enforce its rights to full payment under the contract. The fact that the entity may choose to cancel the contract in the event the customer defaults on its obligations would not affect that assessment (see paragraph 606-10-55-13), provided that the entity’s rights to require the customer to continue to perform as required under the contract (that is, pay the promised consideration) are enforceable.

The example below illustrates the determination of whether and, if so, how to recognize revenue from real estate sales and purchase agreements entered into before the completion of a property project.

Example 8-4

Entity A, a real estate developer, entered into sales and purchase agreements with various buyers before the completion of a property project. The properties are located in Country B. The sales and purchase agreements include the following key terms:

A specific unit is identified in the contract.
Entity A is required to complete the property in all respects in compliance with the conditions set out in the sales agreement and the related building plans within two years from the time when the sales contracts are entered into.
The property remains at A’s risk until delivery.
The buyer is not permitted at any time before delivery to sub-sell the property or transfer the benefit of the agreement. However, the buyer can at any time before the date of assignment mortgage the property to finance the acquisition of the property.
The agreement specifies that the sales agreement can be canceled only when both the buyer and A agree to do so — in effect, the buyer does not have the right to cancel the sales agreement.
If both the buyer and A agree to cancel the contract, A has the right to retain 10 percent of the total purchase price, and the buyer is required to pay for all necessary legal and transaction costs incurred by A in relation to the cancellation.
If A fails to complete the development of the property within the specified two-year period, the buyer has the right to rescind the sales contract and A is required to repay to the buyer all amounts paid by the buyer together with interest. Otherwise, the buyer does not have a right to cancel the contract.
The purchase consideration is payable as follows:
- 5 percent of the entire sale consideration upon entering into the sales agreement.
- 5 percent of the purchase consideration within one month from the date when the sales agreement is entered into.
- 5 percent of the purchase consideration within three months from the date when the sales agreement is entered into.
- The remaining 85 percent of the purchase consideration upon delivery of the property.

Note that for simplicity, this example does not address whether there is a significant financing component.

Under ASC 606, an entity satisfies a performance obligation over time when it transfers control of the promised good or service over time. ASC 606-10-25-27 states that an entity transfers control of a good or service over time and, consequently, satisfies a performance obligation and recognizes revenue over time if one of the following criteria is met:

The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs . . . .
The entity’s performance creates or enhances an asset (for example, work in process) that the customer controls as the asset is created or enhanced . . . .
The entity’s performance does not create an asset with an alternative use to the entity . . . , and the entity has an enforceable right to payment for performance completed to date.

Criterion (a) above is not relevant in the determination of whether revenue from real estate sales (before completion) should be recognized over time or at a point in time. This is because buyers generally do not consume all of the benefits of the property as the real estate developers construct the property; rather, those benefits are consumed in the future.

Criterion (b) above is not directly relevant either because, without further consideration of criterion (c), a conclusion cannot be reached about whether the buyers have control of the property as A develops the property. For example, property buyers may not obtain physical possession of or title to the property until construction is completed.

Entity A should focus on criterion (c), and particularly on (1) whether an asset has been created with an alternative use to the real estate developer and (2) whether the real estate developer has an enforceable right to payment for performance completed to date.

Has an Asset Been Created With an Alternative Use to Entity A?

In accordance with ASC 606-10-25-28, an asset does not have an alternative use to an entity if the entity is either restricted contractually from readily directing the asset for another use during the creation or enhancement of that asset or limited practically from readily directing the asset in its completed state for another use.

With regard to contract restriction, ASC 606-10-55-8 states that the entity does not consider the possibility of a contract termination in assessing whether the entity is able to direct the asset to another customer.

Since each sales contract specifies the unit to be delivered, the property unit does not have an alternative use to A. The contract precludes A from transferring the specified unit to another customer.

Does Entity A Have an Enforceable Right to Payment for Performance Completed to Date?

The payment schedule per the sales and purchase agreement does not correspond to the performance completed to date. However, in assessing whether it has the right to payment for performance completed to date, A should not only consider the payment schedule but should also consider ASC 606-10-55-13, which states:

In some contracts, a customer may have a right to terminate the contract only at specified times during the life of the contract or the customer might not have any right to terminate the contract. If a customer acts to terminate a contract without having the right to terminate the contract at that time (including when a customer fails to perform its obligations as promised), the contract (or other laws) might entitle the entity to continue to transfer to the customer the goods or services promised in the contract and require the customer to pay the consideration promised in exchange for those goods or services. In those circumstances, an entity has a right to payment for performance completed to date because the entity has a right to continue to perform its obligations in accordance with the contract and to require the customer to perform its obligations (which include paying the promised consideration).

In the circumstances under consideration, the contract specifies that the customer cannot terminate the contract unless both the property developer and the buyer agree to do so. In effect, the buyer does not have the discretion to terminate the contract as it wishes.

ASC 606-10-25-28 requires an entity to consider the terms of the contract, as well as any laws that apply to the contract, when evaluating whether it has an enforceable right to payment for performance completed to date. If, taking into account practice and legal precedent in Country B, A has the right to continue to perform the contract and be entitled to all of the consideration as promised, even if the buyer acts to terminate the contract (as articulated in ASC 606-10-55-13 and ASC 606-10-55-88), A has the enforceable right to payment for performance completed to date.

The same response (i.e., the recognition of revenue over time) applies irrespective of whether A allows buyers to choose to pay the consideration on the basis of the agreed-upon payment schedule or to pay all of the consideration up front.

Should Entity A Recognize Revenue Over Time or at a Point in Time?

Since the asset does not have an alternative use to A, and provided that A has an enforceable right to payment for performance completed to date, it should recognize revenue over time. However, if A does not have an enforceable right to payment for the performance completed to date, it should recognize revenue at a point in time (i.e., at the point when the control of the property unit is transferred to the buyer, which would normally be at the time of delivery).

8.4.5.2.1 How and When an Entity Should Determine Whether It Has an Enforceable Right to Payment

In Implementation Q&A 56 (compiled from TRG Agenda Papers 56 and 60), the FASB staff discusses how and when an entity should determine whether it has an enforceable right to payment under ASC 606-10-25-27(c). The staff notes that under ASC 606-10-55-14, an entity should consider the following factors in addition to assessing the terms of the contract:

“[L]egislation, administrative practice, or legal precedent that confers upon the entity a right to payment for performance to date even though that right is not specified in the contract with the customer.”
“[R]elevant legal precedent that indicates that similar rights to payment for performance completed to date in similar contracts [have] no binding legal effect.”
An “entity’s customary business practice of choosing not to enforce a right to payment that has resulted in the right being rendered unenforceable in that legal environment.”

The determination should be made at contract inception. To illustrate its analysis, the FASB staff provides the following example:

For each of the last five years, an entity has received an order from a customer for 300 custom ice cream machines. The specifications of the ice cream machines are unique to the customer. In anticipation of the customer’s order this year, the entity starts production of the custom ice cream machines before there is a contract between the parties in the current year. The entity is willing to take the risk of beginning to manufacture custom units before there is a contract because (a) the customer has predictable purchasing behavior and (b) the entity has knowledge of the customer’s performance in the current year and plans for growth from the customer’s public disclosures. The entity and the customer later enter into a contract (that meets all of the criteria in Step 1 of Topic 606) for 300 units. The entity has a practical limitation on its ability to direct the equipment in its completed state because it could not do so without incurring a significant economic loss. The entity has an enforceable right to payment beginning when the contract is executed. Assume that each of the machines is distinct. At the inception of the contract, the entity has completed 50 units (that is, 50 units are in inventory awaiting shipment to the customer), has 10 units in production (that is, 10 units are in various stages of the manufacturing process), and has not begun manufacturing 240 units.

The staff concludes that at contract inception, the performance obligation to transfer 300 units meets the criteria for recognizing revenue over time because (1) the ice cream machines do not have an alternative use to the entity (i.e., because significant rework would be needed to redirect the assets to another customer) and (2) the entity has an enforceable right to payment for progress completed to date. Although the entity did not have an enforceable right to payment when it was customizing the ice cream machines in anticipation of a customer order, the criteria were met as soon as a valid and genuine contract existed. Consequently, the performance obligation to transfer 300 units to the customer is satisfied over time in accordance with ASC 606-10-25-27(c).

In the staff’s example, the entity also meets the requirements in ASC 606-10-25-14 and 25-15 to account for the transfer of the 300 units as a series of distinct goods or services that constitute a single performance obligation. The entity would record (1) a cumulative catch-up adjustment to revenue to reflect its progress toward complete satisfaction of its performance obligation to transfer 300 units to its customer and (2) revenue for 50 completed and 10 in-process ice cream machines that will be transferred to the customer once the new contract is executed.

8.4.5.2.2 Impact of Intent and Past Practice on Enforceable Right to Payment

As discussed in ASC 606-10-25-27(c), revenue from a contract should be recognized over time if the “entity’s performance does not create an asset with an alternative use to the entity . . . and the entity has an enforceable right to payment for performance completed to date.” This concept is further discussed in ASC 606-10-55-13, which states, in part:

If a customer acts to terminate a contract without having the right to terminate the contract at that time (including when a customer fails to perform its obligations as promised), the contract (or other laws) might entitle the entity to continue to transfer to the customer the goods or services promised in the contract and require the customer to pay the consideration promised in exchange for those goods or services. In those circumstances, an entity has a right to payment for performance completed to date because the entity has a right to continue to perform its obligations in accordance with the contract and to require the customer to perform its obligations (which include paying the promised consideration). [Emphasis added]

An entity may have an established practice of not enforcing its contractual or legal rights (e.g., not continuing to transfer the goods or services for which it could seek payment, not seeking a reimbursement in excess of cost, not collecting a penalty from the customer), or it may assert that it has no intention of enforcing its contractual or legal rights.

However, an entity generally should not consider its intent or past practice related to the enforcement of contractual or legal rights when performing an evaluation under ASC 606-10-25-29 to determine whether the enforceable right to payment criterion in ASC 606-10-25-27(c) is met. The determination of whether an enforceable right to payment exists is evaluated under the terms of the contractual arrangement as a matter of law. An entity’s intent or past practice related to the enforcement of contractual or legal rights should be considered only if the intent or past practice has created a legal precedent as a matter of law that negates the enforceable right in a contract.

This is consistent with ASC 606-10-25-29, which states, in part:

An entity shall consider the terms of the contract, as well as any laws that apply to the contract, when evaluating whether it has an enforceable right to payment for performance completed to date in accordance with paragraph 606-10-25-27(c).

ASC 606-10-55-14 provides additional insight into the application of ASC 606-10-25-29. It states, in part, that the assessment of whether an entity has an enforceable right to payment should take into account whether:

Legislation, administrative practice, or legal precedent confers upon the entity a right to payment for performance to date even though that right is not specified in the contract with the customer.
Relevant legal precedent indicates that similar rights to payment for performance completed to date in similar contracts have no binding legal effect.
An entity’s customary business practices of choosing not to enforce a right to payment has resulted in the right being rendered unenforceable in that legal environment.

The above issue is addressed in Implementation Q&A 56 (compiled from TRG Agenda Papers 56 and 60). For additional information and Deloitte’s summary of issues discussed in the Implementation Q&As, see Appendix C.

Connecting the Dots

ASC 606-10-25-29 provides that an “entity shall consider the terms of the contract, as well as any laws that apply to the contract, when evaluating whether it has an enforceable right to payment for performance completed to date in accordance with paragraph 606-10-25-27(c)” (emphasis added). In practice, it may be uncommon for an entity to pursue legal action against a customer if the customer canceled a contract, especially when there is an ongoing customer-vendor relationship. That is, entities may elect not to enforce their legal right to payment.

For example, suppose that Company A and Customer M have a long-standing relationship. Although A may have a legal right to recover its costs plus a reasonable profit margin if M terminates a contract, A and M may intend to negotiate a settlement to preserve the relationship in the event that a contract is terminated. Regardless of the likelihood that A would enforce its right to full payment from M, the criterion in ASC 606-10-25-27(c) is met as long as A has a legally enforceable right to payment that includes recovery of its costs plus a reasonable profit margin.

In addition to the above, entities should consider instances in which their past practice has rendered their right to payment unenforceable.

8.4.5.2.3 Whether an Entity Has an Enforceable Right to Payment Upon Contract Termination When No Such Right Is Specified in the Contract

Questions about the application of ASC 606-10-55-14(a) or (b) may arise when an entity creates a good with no alternative use and the written terms of the contract with the entity’s customer do not specify the entity’s right to payment upon contract termination. For example, this situation could occur in the United States, where the Uniform Commercial Code (UCC) or a state equivalent of the UCC is applied upon contract termination.

We believe that when a contract’s written terms do not specify the entity’s right to payment upon contract termination, an enforceable right to payment for performance completed to date is presumed not to exist.

However, if the contract with the customer does not specify by its written terms the entity’s right to payment upon contract termination and the entity asserts that it has an enforceable right to payment for performance completed to date, we would expect the entity to:

Support its assertion on the basis of legislation, administrative practice, or legal precedent that confers upon the entity a right to payment for performance to date, as stated in ASC 606-10-55-14(a). This analysis would need to demonstrate that an enforceable right to payment (as defined by ASC 606) exists in the relevant jurisdiction. The fact that the entity would have a basis for making a claim against the counterparty in a court of law would not be sufficient to support the existence of an enforceable right to payment.
Assess whether relevant legal precedent indicates that similar rights to payment for performance completed to date in similar contracts have no binding legal effect, as stated in ASC 606-10-55-14(b).

8.4.5.2.4 Impact of Shipping Terms on Revenue Recognition Over Time

Shipping terms in a contract that require a customer to pay only at a specific point in time (e.g., “free on board” [FOB] destination) do not preclude the contract from meeting the criterion in ASC 606-10-25-27(c) for revenue recognition over time (specifically, the enforceable right to payment condition).

The guidance in ASC 606-10-55-12 makes clear that an enforceable right to payment “need not be a present unconditional right to payment” and that an entity may have “an unconditional right to payment only . . . upon complete satisfaction of the performance obligation.” In these circumstances, the guidance states, “an entity should consider whether it would have an enforceable right to demand or retain payment for performance completed to date if the contract were to be terminated before completion for reasons other than the entity’s failure to perform as promised” (emphasis added).

When a contract’s shipping terms require an entity’s customer to pay only at a specific point in time (e.g., FOB destination), the possibility that the entity will not be paid if the goods are lost in shipment would represent “the entity’s failure to perform as promised” and should be disregarded in the entity’s assessment of whether the performance obligation meets the criterion in ASC 606-10-25-27(c) for revenue recognition over time (i.e., when an entity is assessing whether it has an enforceable right to payment, it should presume that it will perform as promised and that the goods will be delivered). Accordingly, the conclusion that the entity has an enforceable right to payment is not precluded when the contract’s payment terms require payment only at specific points in the production or delivery process. Those payment terms may be overruled by contractual rights that give the entity an enforceable right to demand or retain payment (if the entity performs as promised). Therefore, the fact that the customer would not be required to pay for the goods if they were lost in transit would not, by itself, preclude the contract from meeting the criterion in ASC 606-10-25-27(c) for revenue recognition over time.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.