8.5 Measuring Progress for Revenue Recognized Over Time
ASC 606-10
25-31 For each performance
obligation satisfied over time in accordance with paragraphs
606-10-25-27 through 25-29, an entity shall recognize
revenue over time by measuring the progress toward complete
satisfaction of that performance obligation. The objective
when measuring progress is to depict an entity’s performance
in transferring control of goods or services promised to a
customer (that is, the satisfaction of an entity’s
performance obligation).
25-32 An entity shall apply a
single method of measuring progress for each performance
obligation satisfied over time, and the entity shall apply
that method consistently to similar performance obligations
and in similar circumstances. At the end of each reporting
period, an entity shall remeasure its progress toward
complete satisfaction of a performance obligation satisfied
over time.
After determining that a performance obligation is satisfied over
time, an entity must determine the appropriate method for depicting that performance
over time — that is, how far complete the entity’s progress is as of any given
reporting period. This method is described in the revenue standard as the entity’s
measure of progress.
For example, if a contract requires a calendar-year reporting entity
to perform a daily cleaning service for 12 months beginning on January 1, the entity
may, depending on the facts and circumstances, measure progress in any of the
following ways:
-
Based on days passed (i.e., time elapsed) — For example, as of March 31, 90 days have passed, so the entity’s performance is 25 percent complete.
-
Based on costs incurred — For example, as of March 31, the entity has incurred $300,000 of the expected costs of $1 million, so the entity’s performance is 30 percent complete.
-
Based on labor hours — For example, as of March 31, the entity has incurred 260 hours of cleaning of the expected 1,100 hours for the full year. As a result, the entity’s performance is 24 percent complete.
8.5.1 Methods for Measuring Progress
ASC 606-10
Methods for Measuring Progress
25-33 Appropriate methods of
measuring progress include output methods and input
methods. Paragraphs 606-10-55-16 through 55-21 provide
guidance for using output methods and input methods to
measure an entity’s progress toward complete
satisfaction of a performance obligation. In determining
the appropriate method for measuring progress, an entity
shall consider the nature of the good or service that
the entity promised to transfer to the customer.
When a performance obligation is satisfied over time, an entity
must select a measure of progress (e.g., time elapsed, labor hours, costs
incurred) to depict its progress toward complete satisfaction of that
obligation.
In accordance with ASC 606-10-25-33, appropriate methods of
measuring progress include:
-
Output methods — ASC 606-10-55-17 states that output methods “recognize revenue on the basis of direct measurements of the value to the customer of the goods or services transferred to date relative to the remaining goods or services promised under the contract.” These methods include “surveys of performance completed to date, appraisals of results achieved, milestones reached, time elapsed, and units produced or units delivered.” (See Section 8.5.8.)
-
Input methods — ASC 606-10-55-20 states that input methods “recognize revenue on the basis of the entity’s efforts or inputs to the satisfaction of a performance obligation (for example, resources consumed, labor hours expended, costs incurred, time elapsed, or machine hours used) relative to the total expected inputs to the satisfaction of that performance obligation.” (See Section 8.5.9.)
In discussing the selection of a measure of progress, paragraph
BC164 of ASU 2014-09 states:
The [FASB and IASB] decided
that, conceptually, an output measure is the most faithful depiction of an
entity’s performance because it directly measures the value of the goods or
services transferred to the customer. However, the Boards observed that it
would be appropriate for an entity to use an input method if that method
would be less costly and would provide a reasonable proxy for measuring
progress.
The above statement from paragraph BC164 of ASU 2014-09 does
not mean that it is preferable for an entity to use an output method
when measuring progress toward complete satisfaction of a performance
obligation. As stated in paragraph BC159 of ASU 2014-09, an entity does not have
a free choice in selecting an appropriate method of measuring progress toward
complete satisfaction of a performance obligation but should exercise judgment
in identifying a method that fulfills the stated objective in ASC 606-10-25-31
of depicting an entity’s performance in transferring control of goods or
services promised to a customer (i.e., the satisfaction of the performance
obligation).
Neither an input method nor an output method is preferred since
each has benefits and disadvantages that will make it more or less appropriate
to the facts and circumstances of each contract. While an output method is, as
stated in paragraph BC164, conceptually preferable in a general sense, an
appropriate measure of output will not always be directly observable; and
sometimes, an apparent measure of output will not in fact provide an appropriate
measure of an entity’s performance. Information needed to apply an input method
is more likely to be available to an entity without undue cost, but care should
be taken to ensure that any measure of an entity’s inputs used is reflective of
the transfer of control of goods or services to the customer.
Considerations that may be relevant to the selection of a
measure of progress include the following:
-
An output method would not provide a faithful depiction of the entity’s performance if the output selected fails to measure some of the goods or services transferred to the customer. For example, a units-of-delivery or a units-of-production method may sometimes understate an entity’s performance by excluding work in progress that is controlled by the customer. (See paragraph BC165 of ASU 2014-09.)
-
An input method may better reflect progress toward complete satisfaction of a performance obligation over time when (1) the performance obligation consists of a series of distinct goods or services that meets the criteria in ASC 606-10-25-14(b) to be treated as a single performance obligation and (2) the effort required to create and deliver the first units is greater than the effort to create the subsequent units because of the effect of a “learning curve” of efficiencies realized over time. (See paragraph BC314 of ASU 2014-09.)
-
An entity applying an input method must exclude from its measure of progress the costs incurred that (1) do not contribute to the entity’s progress in satisfying a performance obligation (e.g., the costs of unexpected amounts of wasted materials) and (2) are not proportionate to the entity’s progress in satisfying the performance obligation (e.g., the cost of obtaining goods from a vendor that accounts for most of the product’s cost). (See ASC 606-10-55-21.)
8.5.2 Whether Control of a Good or Service Can Be Transferred at Discrete Points in Time When the Underlying Performance Obligation Is Satisfied Over Time
As discussed above, if the entity meets one of the three
criteria in ASC 606-10-25-27, it recognizes revenue over time by using either an
output method or an input method to measure its progress toward complete
satisfaction of the performance obligation. While the revenue standard does not
prescribe which method to use, the entity should select an approach that
faithfully depicts its performance in transferring control of goods or services
promised to a customer.
At the TRG’s April 2016 meeting, the TRG discussed two views
articulated by stakeholders on whether an entity that is performing over time
can transfer control of a good or service underlying a performance obligation at
discrete points in time:
-
View A — Satisfaction of any of the requirements for recognition over time implies that control does not transfer at discrete points in time. Therefore, an entity’s use of an appropriate measure of progress should not result in its recognition of a material asset (e.g., work in progress) for performance the entity has completed. Proponents of View A point to paragraphs BC125, BC128, BC130, BC131, BC135, and BC142 of ASU 2014-09, which clarify that control of any asset (such as work in progress) transfers to the customer as progress is made.
-
View B — Satisfaction of any of the criteria for recognition over time does not preclude transfer of control at discrete points in time. The use of an appropriate measure of progress could therefore result in the recognition of a material asset for performance under a contract. Proponents of View B emphasized that ASC 606-10-25-27(c) specifically “contemplates transfer of control at discrete points in time.” They also noted that the term “could” in paragraph BC135 of ASU 2014-09 implies that in certain circumstances, the customer may not control the asset as performance occurs. In addition, proponents of View B indicated that “if control can never transfer at discrete points in time, certain methods of progress referenced in the new revenue standard [e.g., milestones2] rarely would be permissible.”3
The FASB staff believes (as discussed in Implementation Q&A 51) that View B is
inconsistent with the revenue standard but that View A is appropriate. The staff
reiterates that paragraphs BC125, BC128, BC130, BC131, BC135, and BC142 of ASU
2014-09 clarify that when an entity satisfies any of the three criteria for
recognizing revenue over time, the entity’s performance is an asset that the
customer controls. The staff also indicates that in accordance with paragraph
BC135 of ASU 2014-09, an entity would consider whether it has a right to payment
in determining whether the customer controls an asset. Therefore, in the staff’s
view, control “does not transfer at discrete points in time,” and “an
appropriate measure of progress should not result in an entity recognizing a
material asset that results from the entity’s performance (for example, work in
process).”4
The FASB staff also notes that (1) View A does not prohibit an
entity from recognizing revenue over time if there is a period during which the
entity does not perform any activities toward satisfying its performance
obligation (i.e., if there is a break in the period of performance) and (2)
although Example 27 in the revenue standard refers to milestone payments, the
standard does not conclude that milestones are the appropriate measure of
progress. Therefore, entities must use judgment in selecting an appropriate
measure of progress.
Certain TRG members questioned the FASB staff’s view that there
could be times when an entity may recognize an immaterial asset (e.g., work in
progress) under a recognition-over-time model because the entity’s selected
measure of progress may not perfectly match its performance. Specifically, they
cited ASC 340-40-25-8, which requires an entity to recognize costs related to
satisfied and partially satisfied performance obligations as expenses when they
are incurred.
TRG members indicated that an asset could result from activities
that are not specific to the customer contract (i.e., the creation of general
inventory). They reiterated the importance of understanding the differences
between costs associated with the development of an asset that transfers to a
customer as it is created and costs to develop assets for general inventory
(i.e., before the asset undergoes modifications that are specific to the
customer). One TRG member discussed an example that involved large, complex, and
customized assets. He noted that activities can be performed to assemble parts,
for example, and that such costs may represent inventory (and thus an asset)
because the assets are interchangeable for use in more than one customer
contract.
Because control of the related good or service cannot be
transferred at discrete points in time if a performance obligation meets one of
the criteria in ASC 606-10-25-27, the measure of progress selected for such a
performance obligation should be consistent with the pattern of transfer of
control of the good or service over time and should not result in the
recognition of work in progress (or a similar asset) as the entity performs work
between discrete points of revenue recognition (see Example 13-12).
ASC 606-10-25-27 does not, however, require an entity’s
performance over time to be continuous and uninterrupted. Accordingly, a gap in
the entity’s performance (e.g., if the entity does not perform any activities
toward satisfying the performance obligation in a particular financial reporting
period) does not in itself prevent the entity from recognizing revenue over
time. In addition, as discussed in Section
13.3.3.2, it will typically be appropriate for the entity to
continue to recognize any incurred contract-fulfillment costs related to future
performance as assets, such as inventories and other assets that have not yet
been used in the contract and are still controlled by the entity.
The above issues are addressed in Implementation Q&A 51 (compiled from previously issued
TRG Agenda Papers 53 and 55). For additional information and Deloitte’s summary of
issues discussed in the Implementation Q&As, see Appendix C.
8.5.3 Use of a Multiple Attribution Approach (as Compared With a Single Method for Measuring Progress)
For performance obligations meeting the requirements for revenue
recognition over time, the entity must select a method for measuring progress
toward satisfaction of the performance obligation.
Although the revenue standard indicates that an entity should
apply a single method to measure progress for each performance obligation
satisfied over time, stakeholders have questioned whether an entity may apply
more than one method to measure progress toward satisfaction of a performance
obligation that contains multiple goods and services bundled and recognized over
time. Examples of such circumstances include the following:
-
A cloud computing company provides hosting services to its customers for specified periods that begin once certain up-front implementation activities are completed. The customer cannot access the services in the hosting arrangement until the implementation activities are complete (and no other vendor can perform the implementation). Therefore, the hosting services are combined with the up-front activities to be one performance obligation.
-
A license is provided to a customer at contract inception. However, there is also a service associated with the license that is not considered to be distinct. Therefore, the service is combined with the license to be one performance obligation.
-
A franchisor enters into a license agreement with a new franchisee for a specified number of years with a promise to also provide a fixed number of hours of consulting services in the first year of the agreement. The license is to be satisfied over time. Because both promises in the arrangement are highly interrelated, the license is combined with the consulting services into one performance obligation.
Stakeholders questioned whether it would be acceptable to apply
two different methods for measuring progress even though the contract has only
one performance obligation.
The FASB staff notes that the revenue standard clearly indicates
that “using multiple methods of measuring progress for the same performance
obligation would not be appropriate.”5 Accordingly, the staff concludes that an entity should use a single
measure of progress for each performance obligation identified in the
contract.
In addition, the FASB staff observes that selecting a common
measure of progress may be challenging when a single performance obligation
contains more than one good or service or has multiple payment streams, although
it emphasizes that the selection is not a free choice. Further, the staff notes
that while a common measure of progress that does not depict the economics of
the contract may indicate that the arrangement contains more than one
performance obligation, it is not determinative. However, a reexamination may
suggest that the contract includes more performance obligations than were
initially identified.
The above issues are addressed in Implementation Q&As 47 and 48 (compiled from previously
issued TRG Agenda Papers 41 and 44). For additional information and Deloitte’s summary of
issues discussed in the Implementation Q&As, see Appendix C.
8.5.4 Use of Different Methods of Measuring Performance to Date to Determine Whether a Performance Obligation Is Satisfied Over Time and to Measure Progress Toward Satisfaction of That Performance Obligation
In some circumstances, an entity will need to identity a
suitable method for measuring “performance completed to date” to determine
whether the criterion in ASC 606-10-25-27(c) is met (see ASC 606-10-25-29 and
ASC 606-10-55-11 for additional guidance). Further, once it has been determined
that a performance obligation is satisfied over time, ASC 606-10-25-31 requires
an entity to “recognize revenue over time by measuring the progress toward
complete satisfaction of that performance obligation.” For measuring both
performance completed to date under ASC 606-10-25-27(c) (to determine whether
revenue should be recognized over time) and progress toward complete
satisfaction of a performance obligation under ASC 606-10-25-31, the method
selected should faithfully depict an entity’s performance in transferring
control of goods or services promised to a customer. However, there is no
requirement for the same method to be used for both purposes.
But in determining an appropriate method for measuring progress
under ASC 606-10-25-31, entities should be aware that ASC 606-10-25-32 requires
them to apply the same method to all similar performance obligations in similar
circumstances.
Example 8-5
Entity A enters into a contract with
Customer B under which A will construct a large item of
specialized equipment on its own premises and then
deliver the equipment and transfer title to B after
construction is completed. The specialized equipment is
only suitable for this particular customer (i.e., it has
no alternative use). In addition, the specialized
equipment is subject to certain regulations that require
third-party appraisals to be performed throughout the
construction of the equipment. The objective of the
appraisals is to assess the entity’s construction
progress and ensure that the equipment is built in
accordance with published regulations. The results of
the periodic appraisals are provided to the customer,
and a final appraisal is performed shortly before the
equipment is delivered to the customer.
Entity A concludes that it qualifies to
recognize revenue over time under ASC 606-10-25-27(c) by
using a cost-based input method because if the customer
cancels the contract, the customer must reimburse the
costs incurred by the entity to the date of cancellation
and pay a 5 percent margin on those costs (which is
considered to be a reasonable margin).
However, in measuring the progress
toward satisfaction of similar performance obligations
in other contracts, A uses an output method based on
third-party appraisals completed to date. This method is
determined to faithfully depict progress toward
satisfaction of the performance obligation in the
contract with B. Because ASC 606-10-25-32 requires an
entity to apply the same method of measuring progress to
similar performance obligations in similar
circumstances, A uses this appraisal-based output method
to measure the revenue to be recognized in each
reporting period from its contract with B despite using
a cost-based measure of progress to determine whether it
met the criterion in ASC 606-10-25-27(c).
8.5.5 Application of the Method for Measuring Progress
ASC 606-10
25-34 When applying a method
for measuring progress, an entity shall exclude from the
measure of progress any goods or services for which the
entity does not transfer control to a customer.
Conversely, an entity shall include in the measure of
progress any goods or services for which the entity does
transfer control to a customer when satisfying that
performance obligation.
Under the control principle of the revenue standard, it would
not be appropriate for an entity to recognize revenue for any progress made or
activities performed that do not transfer control to the customer. Rather, the
entity should use judgment to determine which activities are included in the
promised goods or services to the customer and select a method for measuring
progress toward transferring the goods or services to the customer.
This concept is also aligned with principal-versus-agent
considerations in that if the entity does not transfer control to the customer
but coordinates the transfer directly to the customer from a third party (i.e.,
the entity does not control the good or service before it is transferred to the
customer), it would be inappropriate to include the component part in the
measure of progress, and revenue should therefore be adjusted accordingly. See
Chapter 10 for further
discussion of principal-versus-agent considerations.
8.5.6 Subsequent Measurement of an Entity’s Measure of Progress
ASC 606-10
25-35 As circumstances change
over time, an entity shall update its measure of
progress to reflect any changes in the outcome of the
performance obligation. Such changes to an entity’s
measure of progress shall be accounted for as a change
in accounting estimate in accordance with Subtopic
250-10 on accounting changes and error corrections.
It is common for estimates related to an entity’s level of
progress to change as the entity fulfills its promise to the customer. As a
result, such estimates of an entity’s measure of progress should be updated on
the basis of the most current information available to the entity. Consideration
should be given to subsequent measurement to the extent that there are any
changes in the outcome of the performance obligation. Such changes should be
accounted for in a manner consistent with the guidance on accounting changes in
ASC 250, which states that a “change in accounting estimate shall be accounted
for in the period of change if the change affects that period only or in the
period of change and future periods if the change affects both.” Accordingly, a
change in the entity’s estimated measure of progress should be accounted for
prospectively (i.e., prior periods are not restated, but there could be a
cumulative-effect adjustment to revenue in the current period). Because the
change represents a change in accounting estimate rather than any change in the
scope or price of the contract, the guidance in the revenue standard on contract
modifications (discussed in Chapter 9) would not apply. In addition, since this estimate is
related to an entity’s recognition of revenue rather than measurement of
revenue, the guidance on accounting for changes in the estimate of variable
consideration (discussed in Chapter 7) would not apply.
Example 8-6
Entity A enters into a contract to construct a building
in exchange for a fixed price of $2 million. Entity A
concludes that it has a single performance obligation
and that one of the criteria for recognizing revenue
over time is met. In addition, A concludes that an input
method is the most appropriate method for measuring its
progress toward complete satisfaction. Accordingly, A
measures its progress on the basis of costs incurred to
date as compared with total expected costs.
At contract inception, A estimates that it will incur
total costs of $900,000. After A incurs actual costs of
$450,000, its estimate of total costs changes from
$900,000 to $800,000. This change represents a change in
accounting estimate and should be accounted for as
follows:
-
Amount of revenue recognized to date — ($450,000 ÷ $900,000) × $2 million = $1 million.
-
Amount of revenue that should be recognized on the basis of the new estimate — ($450,000 ÷ $800,000) × $2 million = $1.125 million.
-
Amount of revenue recognized upon change in estimate — $1.125 million − $1 million = $125,000.
In some instances, an entity may use time-based measures of progress to recognize
revenue for a performance obligation that is satisfied over time. When there is
uncertainty about the period over which a performance obligation will be
satisfied, an entity may need to update its estimate of the amount of time that
will be required to completely satisfy the performance obligation. For example,
an entity that has an obligation to stand ready to provide services for the life
of a customer may need to update its estimate related to how long a customer
will require the entity to stand ready to provide services. Such a scenario is
illustrated below.
Exmaple 8-6A
Company B is an online game company that allows customers
to access and play Game X for no charge. To enhance
customers’ gaming experience, B gives customers the
option to purchase virtual clothing for their Game X
avatars. Company B has determined that (1) the nature of
its promise is to host an online game that displays
virtual clothing and (2) virtual clothing is a form of
durable good. It concludes that once a purchase of
virtual clothing is made, it has an obligation to host
the piece of virtual clothing in the online game for the
life of the customer and has met one of the criteria for
recognizing revenue over time. Accordingly, B recognizes
revenue over the period in which the customer benefits
from the virtual clothing displayed in the online game
(which is the life of the customer).
During January 20X1, customers of B purchase $3 million
in virtual clothing. Assume that (1) all customers are
part of the same customer cohort and (2) B estimates
that the cohort of customers will have a three-year
life. Company B records revenue of $1 million in each of
the years 20X1 and 20X2 for this cohort of
customers.
On December 31, 20X2, B updates its estimate of the
customer life (i.e., the period over which it expects
customers to benefit from the virtual clothing) to four
years. We believe that B can apply either of the two
approaches described below to account for this change in
estimate. The selected approach is an accounting policy
that should be consistently applied.
Approach 1 — Prospective Accounting
If B applies the prospective accounting approach, it
would account for the change in estimate as follows:
- Amount of revenue recognized to date — (2 years ÷ 3 years) × $3 million = $2 million.
- Amount of remaining revenue that should be recognized over remainder of new term — $3 million − $2 million = $1 million.
- Amount of revenue to be recognized annually after the change in estimate — $1 million ÷ 2 additional years = $500,000 per year.
Approach 2 — Cumulative Adjustment
If B applies the cumulative adjustment approach, it would
account for the change in estimate as follows:
- Amount of revenue recognized to date — (2 years ÷ 3 years) × $3 million = $2 million.
- Amount of revenue that should be recognized on the basis of the new estimate — (2 years ÷ 4 years) × $3 million = $1.5 million.
- Amount of revenue recognized upon change in estimate — $1.5 million − $2 million = $(500,000). This would result in B’s recognition of $250,000 in revenue in 20X3 and $750,000 in revenue in 20X4.
8.5.7 Reasonable Measure of Progress
ASC 606-10
Reasonable Measures
of Progress
25-36 An entity shall recognize
revenue for a performance obligation satisfied over time
only if the entity can reasonably measure its progress
toward complete satisfaction of the performance
obligation. An entity would not be able to reasonably
measure its progress toward complete satisfaction of a
performance obligation if it lacks reliable information
that would be required to apply an appropriate method of
measuring progress.
25-37 In some circumstances
(for example, in the early stages of a contract), an
entity may not be able to reasonably measure the outcome
of a performance obligation, but the entity expects to
recover the costs incurred in satisfying the performance
obligation. In those circumstances, the entity shall
recognize revenue only to the extent of the costs
incurred until such time that it can reasonably measure
the outcome of the performance obligation.
As discussed in Section 8.5.1, the revenue standard
requires an entity to select the method that faithfully depicts its progress
toward completion. However, in some circumstances, an entity may not be able to
reasonably measure progress toward completion.
During the development of the revenue standard, feedback
considered by the FASB and IASB suggested that recognizing revenue solely on the
basis of costs incurred (resulting in zero margin being recognized) is a widely
understood and reasonable practice. As a result, the boards agreed that this is
an important recognition practice and decided to incorporate the concept into
the revenue standard. Specifically, the boards concluded that if an entity
cannot reasonably measure progress but still expects to recover the costs
incurred to satisfy the performance obligation, the entity should recognize
revenue for its progress in satisfying the performance obligation by recognizing
revenue in the amount of the costs incurred. However, this would only be
appropriate if the entity cannot reasonably measure its progress, or until the
entity is able to reasonably measure progress. In addition, an entity may need
to evaluate whether it is required to recognize losses in its financial
statements before those losses are incurred. Refer to Chapter 13 for considerations related to
onerous performance obligations and recognition of such losses.
Importantly, this evaluation is separate from estimating and
constraining variable consideration. Therefore, in long-term contracts, there
are typically at least two key estimates made at contract inception and
reassessed during the contract: (1) the entity’s current measure of progress
and, separately, (2) the entity’s current estimate of any variable consideration
(see Chapter 6 for
further discussion).
The example below illustrates a situation in which progress
toward complete satisfaction of a performance obligation cannot be reasonably
measured.
Example 8-7
A contractor enters into a building
contract with fixed consideration of $1,000. The
contract is expected to take three years to complete and
satisfies one of the criteria in ASC 606-10-25-27 for
revenue to be recognized over time. At the end of year
1, management is unable to reasonably measure its
progress toward complete satisfaction of the performance
obligation (e.g., because it cannot reasonably measure
total costs under the contract). Taking into account the
progress to date and future expectations, management
expects that total contract costs will not exceed total
contract revenues. Costs of $100 have been incurred in
year 1.
In this example, since the contractor is
not able to reasonably measure the progress relative to
the work performed to date but expects that costs are
recoverable, only revenue of $100 should be recognized
in year 1. Therefore, in year 1, revenue and costs of
services of $100 are recognized, resulting in no profit
margin.
8.5.8 Output Methods
The revenue standard outlines two types of methods for measuring
progress: output methods and input methods. As stated in ASC 606-10-55-17,
output methods “recognize revenue on the basis of direct measurements of the
value to the customer of the goods or services transferred to date relative to
the remaining goods or services promised under the contract.” Examples of output
methods include surveys of performance completed to date, appraisals of results
achieved, milestones reached, time elapsed, and units delivered or produced.
Value to the customer should be an objective measure of the entity’s performance
(i.e., the measure is directly observable, and information needed to apply the
measure is readily available).
ASC 606-10
55-17 Output methods recognize
revenue on the basis of direct measurements of the value
to the customer of the goods or services transferred to
date relative to the remaining goods or services
promised under the contract. Output methods include
methods such as surveys of performance completed to
date, appraisals of results achieved, milestones
reached, time elapsed, and units produced or units
delivered. When an entity evaluates whether to apply an
output method to measure its progress, the entity should
consider whether the output selected would faithfully
depict the entity’s performance toward complete
satisfaction of the performance obligation. An output
method would not provide a faithful depiction of the
entity’s performance if the output selected would fail
to measure some of the goods or services for which
control has transferred to the customer. For example,
output methods based on units produced or units
delivered would not faithfully depict an entity’s
performance in satisfying a performance obligation if,
at the end of the reporting period, the entity’s
performance has produced work in process or finished
goods controlled by the customer that are not included
in the measurement of the output.
55-19 The disadvantages of
output methods are that the outputs used to measure
progress may not be directly observable and the
information required to apply them may not be available
to an entity without undue cost. Therefore, an input
method may be necessary.
Paragraph BC164 of ASU 2014-09 states that the FASB and IASB
“decided that, conceptually, an output measure is the most faithful depiction of
an entity’s performance because it directly measures the value of the goods or
services transferred to the customer.” That is, the boards did not state that an
output method is the preferred method but instead indicated that in most cases,
an output method would be the most appropriate method that is consistent with
recognizing revenue as value is transferred to the customer. Some stakeholders
argue that an output method is generally the most appropriate method. However, a
drawback of using an output method is that there may not always be a directly
observable or objectively determined output to reliably measure an entity’s
progress, and it could fail to measure progress between directly observable or
objectively determined outputs. As a result, the boards noted that there may be
instances in which it would be appropriate for an entity to use an input method
(i.e., if that method would be less costly and would provide a reasonable
measure of progress).
In redeliberations of the revenue standard, some stakeholders
requested that the boards provide more guidance on when units-of-delivery or
units-of-production methods would be appropriate. Although such methods appear
to be output methods, they do not always provide the most faithful depiction of
the entity’s performance. That is, these methods may disregard an entity’s
efforts that result in progress toward completion when performance is satisfied
over time, which could be material to the contract or even the financial
statements as a whole. In addition, units-of-production or units-of-delivery
methods may not be appropriate in contracts that provide design and production
services because the transfer of produced items may not correspond to the actual
progress made on the entire contract.
Therefore, in the selection of an output method for measuring
progress and the determination of whether a units-of-delivery or
units-of-production method is appropriate, it is important for an entity to
carefully consider (1) all of the facts and circumstances of the arrangement and
(2) how value is transferred to the customer.
8.5.8.1 Invoice Practical Expedient for Measuring Progress
ASC 606-10
55-18 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 revenue standard provides a practical expedient in ASC
606-10-55-18 that can be applied to performance obligations that meet the
criteria in ASC 606-10-25-27 to be satisfied over time. Most commonly
referred to as the “invoice practical expedient,” this option allows an
entity to recognize revenue in the amount of consideration to which the
entity has the right to invoice when the amount that the entity has the
right to invoice corresponds directly to the value transferred to the
customer. That is, the invoice practical expedient cannot be applied in all
circumstances because the right to invoice a certain amount does not always
correspond to the progress toward satisfying the performance obligation.
Therefore, an entity should demonstrate its ability to apply the invoice
practical expedient to performance obligations satisfied over time. Because
the purpose of the invoice practical expedient is to faithfully depict an
entity’s measure of progress toward completion, the invoice practical
expedient can only be applied to performance obligations satisfied over time
(not at a point in time).
8.5.8.1.1 Using the Invoice Practical Expedient When the Unit Price or Rate Varies During the Contract Period
The option to apply the invoice practical expedient in
ASC 606-10-55-18 is available only if the invoice amount represents the
“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).”6
Stakeholders have questioned whether the invoice
practical expedient may be used for contracts in which the unit price or
rate varies during the contract period.
The FASB staff has noted that an entity must use
judgment and that conclusions are likely to vary depending on the facts
and circumstances. The staff believes that the invoice practical
expedient could be used for both a contract in which the unit price
varies during the contract period and a contract in which the rate
varies during the contract period if the contracts’ respective price and
rate changes reflect the “value to the customer of each incremental good
or service that the entity transfers to the customer.”7
Connecting the Dots
In some industries, the price charged to the customer for each
unit transferred may vary over the contract term. For example, a
contract to supply electricity for several years may specify
different unit prices each year depending on the forward market
price of electricity at contract inception.
In this example, the contract to purchase electricity at prices
that vary over the term of the contract depending on the forward
market price of electricity at contract inception would qualify
for the practical expedient because the rates per unit generally
correlate to the value to the customer of the entity’s provision
of each unit of electricity.
The above issue is addressed in Implementation Q&A 46 (compiled from previously
issued TRG Agenda Papers 40 and 44). For additional information and Deloitte’s
summary of issues discussed in the Implementation Q&As, see
Appendix
C.
8.5.8.1.2 Applying the Invoice Practical Expedient to Contracts With Up-Front Consideration or Back-End Fees
An entity is not necessarily precluded from applying the
invoice practical expedient in ASC 606-10-55-18 when a contract contains
nonrefundable up-front consideration or back-end fees. However, the
entity will need to use judgment in determining whether the amount
invoiced for goods or services reasonably represents the value to the
customer of the entity’s performance completed to date.
When the entity makes this assessment, an analysis of
the significance of the up-front or back-end fees relative to the other
consideration in the arrangement is likely to be important.
The above issue is addressed in Implementation Q&A 46 (compiled from previously
issued TRG Agenda Papers 40 and 44). For additional information and Deloitte’s
summary of issues discussed in the Implementation Q&As, see
Appendix
C.
8.5.9 Input Methods
Input methods recognize revenue on the basis of an entity’s
efforts or inputs toward satisfying a performance obligation. Examples include
resources consumed, labor hours expended, costs incurred, time elapsed, or
machine hours used.
ASC 606-10
55-20 Input methods recognize
revenue on the basis of the entity’s efforts or inputs
to the satisfaction of a performance obligation (for
example, resources consumed, labor hours expended, costs
incurred, time elapsed, or machine hours used) relative
to the total expected inputs to the satisfaction of that
performance obligation. If the entity’s efforts or
inputs are expended evenly throughout the performance
period, it may be appropriate for the entity to
recognize revenue on a straight-line basis.
A common input method is the “cost-to-cost” method, as implied
by the use of the term “costs incurred” in ASC 606-10-55-20 as an example of a
basis for measuring progress. When applying the cost-to-cost method, an entity
uses costs incurred as compared with total estimated costs. Types of costs that
an entity may consider when applying the cost-to-cost method include direct
labor, direct materials, subcontractor costs, and other costs incurred that are
related to the entity’s performance under a contract. In addition, while certain
overhead costs may be appropriate for consideration under the cost-to-cost
method, an entity should use judgment to include only allocated costs (in
measuring progress) that actually contribute to the transfer of control to the
customer of the performance obligation(s). For example, it would generally not
be appropriate for an entity to include general and administrative costs or
sales and marketing costs in measuring the progress toward satisfying a
performance obligation unless (1) those costs are directly chargeable to the
customer and (2) including such costs faithfully depicts the entity’s progress
toward satisfying the performance obligation. In making this distinction,
entities may refer to ASC 340-40-25-7, which includes types of costs that are
directly related to a contract.
8.5.9.1 Inefficiencies and Wasted Materials
ASC 606-10
55-21 A shortcoming of input
methods is that there may not be a direct
relationship between an entity’s inputs and the
transfer of control of goods or services to a
customer. Therefore, an entity should exclude from
an input method the effects of any inputs that, in
accordance with the objective of measuring progress
in paragraph 606-10-25-31, do not depict the
entity’s performance in transferring control of
goods or services to the customer. For instance,
when using a cost-based input method, an adjustment
to the measure of progress may be required in the
following circumstances:
-
When a cost incurred does not contribute to an entity’s progress in satisfying the performance obligation. For example, an entity would not recognize revenue on the basis of costs incurred that are attributable to significant inefficiencies in the entity’s performance that were not reflected in the price of the contract (for example, the costs of unexpected amounts of wasted materials, labor, or other resources that were incurred to satisfy the performance obligation). . . .
While an entity may conclude that an input method is the
most appropriate method to measure progress of a contract (e.g.,
cost-to-cost method), there may be instances or anomalies in which costs
incurred are attributable to inefficiencies or wasted materials and do not
contribute to the satisfaction of the performance obligation. In these
circumstances, an entity should exclude such factors that do not accurately
depict the entity’s progress toward satisfying the performance
obligation.
In early drafts of the revenue standard, the FASB and IASB
proposed requiring an entity to exclude inefficiencies and wasted materials
from any input measure (i.e., a cost-to-cost measure). However, many comment
letter respondents explained that often there is an “expected” level of
inefficiency or waste factored into a project from the outset and that
separately, circumstances involving “unexpected” inefficiencies or waste may
occur once a project has commenced. Those comment letter respondents
requested further clarification from the boards regarding the amounts that
should be excluded from any measure of progress. However, instead of
providing additional detailed guidance on “expected” versus “unexpected”
inefficiencies, the boards ultimately decided to emphasize the objective of
measuring progress toward complete satisfaction of the performance
obligation to depict an entity’s performance in the contract. That is, when
an input method is used, it should be adjusted if it is not truly depicting
the measure of progress.
In many construction and manufacturing contracts, some level
of wastage is normal and unavoidable as part of the construction or
manufacturing process. Expected levels of such wastage will be forecasted in
an entity’s budgets and estimates and included in contract costs. However,
there may be circumstances in which an entity experiences significant
unexpected levels of wasted materials, labor, or other resources.
ASC 606 contains specific guidance on accounting for costs
of fulfilling a contract. ASC 340-40-25- 8(b) specifies that costs of wasted
materials, labor, or other resources to fulfill a contract that are not
reflected in the price of the contract should be recognized as expenses when
incurred.
Abnormal waste costs do not represent additional progress
toward satisfaction of an entity’s performance obligation and, if revenue is
being recognized over time, should be excluded from the measurement of such
progress. If the entity is using costs incurred to date as an input method
to measure progress toward complete satisfaction of its performance
obligation, it should be careful to ensure that revenue attributed to work
carried out is not increased to offset additional costs incurred when
abnormal or excessive costs arise as a result of inefficiency or error. In
particular, ASC 606-10-55-21(a) states that when using a cost-based input
method, entities may be required to adjust the measure of progress when
costs are incurred that are “attributable to significant inefficiencies in
the entity’s performance that were not reflected in the price of the
contract.”
8.5.9.2 Uninstalled Materials
ASC 606-10
55-21 A shortcoming of input
methods is that there may not be a direct
relationship between an entity’s inputs and the
transfer of control of goods or services to a
customer. Therefore, an entity should exclude from
an input method the effects of any inputs that, in
accordance with the objective of measuring progress
in paragraph 606-10-25-31, do not depict the
entity’s performance in transferring control of
goods or services to the customer. For instance,
when using a cost-based input method, an adjustment
to the measure of progress may be required in the
following circumstances: . . .
b. When a cost incurred is not proportionate
to the entity’s progress in satisfying the
performance obligation. In those circumstances,
the best depiction of the entity’s performance may
be to adjust the input method to recognize revenue
only to the extent of that cost incurred. For
example, a faithful depiction of an entity’s
performance might be to recognize revenue at an
amount equal to the cost of a good used to satisfy
a performance obligation if the entity expects at
contract inception that all of the following
conditions would be met:
1. The good is not
distinct.
2. The customer is
expected to obtain control of the good
significantly before receiving services related to
the good.
3. The cost of the
transferred good is significant relative to the
total expected costs to completely satisfy the
performance obligation.
4. The entity procures
the good from a third party and is not
significantly involved in designing and
manufacturing the good (but the entity is acting
as a principal in accordance with paragraphs
606-10- 55-36 through 55-40).
There may be instances in which an entity is acting as a
principal and promises to deliver a good and a service that are not distinct
from each other, but the good is transferred before the service is provided.
For example, this could occur when a piece of equipment is transferred to
the customer, but the entity has also promised to install the equipment or
the piece of equipment is a component part of an overall highly customized
project being provided to the customer. In these types of circumstances, a
strict, literal interpretation of an input method to measure progress may
not be appropriate, and the entity may need to carefully consider its actual
progress toward completion. To assist in the interpretation of the revenue
standard’s general guidance on input methods in these circumstances, the
boards provided additional guidance (see ASC 606-10-55-21(b), reproduced
above) and included an example illustrating the treatment of uninstalled
materials (see Example 19, reproduced below).
Through both the additional guidance and the example, the
boards clarified that the adjustment to the input method for uninstalled
materials was to ensure that the input method is consistent with the
objective of measuring progress toward complete satisfaction of a
performance obligation.
In the scenario described above (the promised delivery and
installation of equipment), it would be inappropriate to continue
recognizing the equipment as inventory after delivery but before
installation. Rather, the entity should recognize revenue for the entity’s
performance (i.e., for the delivery of the equipment) in accordance with the
core principle of the standard. However, the boards acknowledged that an
entity may have difficulty determining the amount of revenue to recognize
for the delivery of the equipment when the delivery is not distinct from the
installation. For example, if the entity were to use a cost-to-cost method
to measure progress, resulting in recognition of a contract-wide profit
margin for the delivery of the equipment, the entity’s performance could
consequently be overstated, resulting in an overstatement of revenue.
Another option would be for the entity to estimate a profit margin (which
differs from the contract-wide profit margin); however, this approach would
be complex and could result in the recognition of too much revenue for the
transfer of goods or services that are not distinct. Ultimately, the boards
decided that in certain circumstances, an entity should only recognize
revenue in the amount of the cost of those goods that have been transferred
to the customer (and not include any amount of profit margins). This
adjustment is necessary if delivery of the uninstalled good does not depict
the entity’s performance. This adjustment to the cost-to-cost measure of
progress is most appropriate for scenarios in which the goods (e.g., the
equipment) compose a large portion of the total cost of the contract, and it
ensures that the input method meets the objective of measuring progress to
depict the entity’s performance.
In addition, the boards also clarified that if an entity
selects an input method, (e.g., the cost-to-cost method), it would need to
adjust the measure of progress if including some of the costs incurred would
not truly depict the entity’s performance in the contract.
ASC 606-10
Example 19 — Uninstalled
Materials
55-187 In November 20X2, an
entity contracts with a customer to refurbish a
3-story building and install new elevators for total
consideration of $5 million. The promised
refurbishment service, including the installation of
elevators, is a single performance obligation
satisfied over time. Total expected costs are $4
million, including $1.5 million for the elevators.
The entity determines that it acts as a principal in
accordance with paragraphs 606-10-55-36 through
55-40 because it obtains control of the elevators
before they are transferred to the customer.
55-188 A summary of the
transaction price and expected costs is as
follows:
55-189 The entity uses an
input method based on costs incurred to measure its
progress toward complete satisfaction of the
performance obligation. The entity assesses whether
the costs incurred to procure the elevators are
proportionate to the entity’s progress in satisfying
the performance obligation in accordance with
paragraph 606-10-55-21. The customer obtains control
of the elevators when they are delivered to the site
in December 20X2, although the elevators will not be
installed until June 20X3. The costs to procure the
elevators ($1.5 million) are significant relative to
the total expected costs to completely satisfy the
performance obligation ($4 million). The entity is
not involved in designing or manufacturing the
elevators.
55-190 The entity concludes
that including the costs to procure the elevators in
the measure of progress would overstate the extent
of the entity’s performance. Consequently, in
accordance with paragraph 606-10- 55-21, the entity
adjusts its measure of progress to exclude the costs
to procure the elevators from the measure of costs
incurred and from the transaction price. The entity
recognizes revenue for the transfer of the elevators
in an amount equal to the costs to procure the
elevators (that is, at a zero margin).
55-191 As of December 31,
20X2, the entity observes that:
-
Other costs incurred (excluding elevators) are $500,000.
-
Performance is 20% complete (that is, $500,000 ÷ $2,500,000).
55-192 Consequently, at
December 31, 20X2, the entity recognizes the
following:
The example below illustrates the treatment of prepaid costs
for work to be performed in the future.
Example 8-8
A contractor undertakes a three-year
contract. At the end of year 1, management estimates
that the total revenue on the contract will be
$1,000 and that total costs will be $900, of which
$300 has been incurred to date. Of the $300 incurred
to date, $50 is related to materials purchased in
year 1 that will be used in year 2. The materials
purchased in advance are generic and were not
specifically produced for the contract. The
contractor has determined that the contract is a
single performance obligation that will be satisfied
over time. To calculate the progress toward complete
satisfaction of its performance obligation, the
contractor uses an input method based on costs
incurred to date in proportion to the total
anticipated contract costs.
ASC 606-10-55-21 states, in part,
that “an entity should exclude from an input method
the effects of any inputs that . . . do not depict
the entity’s performance in transferring control of
goods or services to the customer.”
Materials purchased that have yet to
be used may not form part of the costs that
contribute to the transfer of control of goods or
services to the customer. For example, if materials
have been purchased that the contractor is merely
holding at the job site, and these materials were
not specifically produced or fabricated for any
projects, transfer of control of such materials will
generally not have passed to the customer.
Accordingly, in this example, an
adjustment is required for the purchased materials
not yet used because the materials are related to
the work to be performed in the future, and control
of the materials has not transferred to the
customer, as illustrated below.
Therefore, in year 1, contract
revenue of $280 (28% of $1,000) and contract costs
of $250 are recognized in profit or loss. Contract
costs of $50 corresponding to the purchased
materials not yet used are recognized as
inventories. See also Section 8.5.5.
8.5.9.3 Incremental Costs of Obtaining a Contract
When using an input method, an entity should exclude from
its measure of progress the costs it incurred to obtain the contract with
the customer because such costs do not depict an entity’s performance under
the contract. Chapter
13 discusses how to account for the incremental costs of
obtaining a contract with a customer.
ASC 606-10-25-31 states that an entity’s objective, when
measuring progress, is to depict its performance in transferring control of
goods or services promised to a customer. ASC 606-10-55-21 also specifies
that inputs that do not depict such performance are excluded from the
measurement of progress under an input method.
Costs of obtaining a contract are not a measure of
fulfilling it and, accordingly, are excluded from the measurement of
progress (both the measure of progress to date and the estimate of total
costs incurred to satisfy the performance obligation) irrespective of
whether they are recognized as an asset in accordance with ASC 340-40-25-1.
Under ASC 340-40-35-1, such an asset is “amortized on a systematic basis
that is consistent with the transfer to the customer of the goods or
services to which the asset relates” (see Chapter 13 for additional
information). Accordingly, rather than being used to determine the pattern
of revenue recognition, capitalized costs of obtaining a contract are
amortized in accordance with the expected pattern of transfer of goods or
services. In contrast, costs of fulfilling the contract that depict an
entity’s performance would be included in the measurement of progress.
8.5.10 Measuring Progress — Stand-Ready Obligations
As discussed in Section 5.4.3, step 2 of the revenue model (i.e., identify the
performance obligations) addresses how to assess the nature of a stand-ready
obligation on the basis of what, in fact, the entity is promising to deliver to
the customer (i.e., a discrete set of performance obligations over a fixed
period or a performance obligation that is unlimited over a fixed period). This
concept is illustrated in Example 18 of ASC 606, which is reproduced below.
ASC 606-10
Example 18 — Measuring Progress When
Making Goods or Services Available
55-184 An entity, an owner
and manager of health clubs, enters into a contract with
a customer for one year of access to any of its health
clubs. The customer has unlimited use of the health
clubs and promises to pay $100 per month.
55-185 The entity determines
that its promise to the customer is to provide a service
of making the health clubs available for the customer to
use as and when the customer wishes. This is because the
extent to which the customer uses the health clubs does
not affect the amount of the remaining goods and
services to which the customer is entitled. The entity
concludes that the customer simultaneously receives and
consumes the benefits of the entity’s performance as it
performs by making the health clubs available.
Consequently, the entity’s performance obligation is
satisfied over time in accordance with paragraph
606-10-25-27(a).
55-186 The entity also
determines that the customer benefits from the entity’s
service of making the health clubs available evenly
throughout the year. (That is, the customer benefits
from having the health clubs available, regardless of
whether the customer uses it or not.) Consequently, the
entity concludes that the best measure of progress
toward complete satisfaction of the performance
obligation over time is a time-based measure, and it
recognizes revenue on a straight-line basis throughout
the year at $100 per month.
For a stand-ready obligation that is satisfied over time, an
entity may measure progress toward complete satisfaction of the performance
obligation by using one of various methods, including input and output methods.
Although ASC 606-10-55-16 through 55-21 provide guidance on when an entity would
use an output or input method, the guidance does not prescribe the use of either
method. However, an entity does not have a “free choice” when selecting a
measure of progress. While an entity may use either type of method, the actual
method selected should be consistent with the clearly stated objective of
depicting the entity’s performance (i.e., the entity’s satisfaction of its
performance obligation in transferring control of goods or services to the
customer).
Further, although ASC 606 does not permit an entity to default
to a straight-line measure of progress on the basis of the passage of time
(because a straight-line measure of progress may not faithfully depict the
pattern of transfer), ASC 606 does not prohibit the use of a straight-line
measure of progress, and such a time-based method may be reasonable in some
cases depending on the facts and circumstances. An entity would need to use
judgment to select an appropriate measure of progress on the basis of the
arrangement’s particular facts and circumstances.
Example 18 in ASC 606-10-55-184 through 55-186 illustrates a
health club membership involving an entity’s stand-ready obligation to provide a
customer with one year of access to any of the entity’s health clubs. In the
example, the entity determines that the customer benefits from the stand-ready
obligation evenly throughout the year.
Other examples of stand-ready obligations include the
following:
-
Snow removal services — An entity promises to remove snow on an “as needed” basis (i.e., a single amount is paid irrespective of the number of times the snow removal services are performed). In this type of arrangement, the entity does not know and most likely cannot reasonably estimate whether, how often, and how much it will snow. This suggests that the entity’s promise is to stand ready to provide the snow-removal services on a when-and-if-needed basis. As a result, a time-based measure of progress may be appropriate. However, a pure straight-line recognition pattern over each month of an annual contract may not be reasonable if that would allow recognition of revenue during months (i.e., warmer months) when the entity either is not performing or is performing to a markedly reduced extent. For such a fixed-fee service contract, although the contract term is fixed (i.e., one year), the pattern of benefit of the services to the customer, as well as the entity’s efforts to fulfill the contract, would most likely vary throughout the year because there would be less expectation of snowfall during the warmer months of the year.
-
Unspecified software upgrades — An entity promises to make unspecified (i.e., when-and-if-available) software upgrades available to a customer. The nature of the entity’s promise is fundamentally one of providing the customer with assurance that any upgrades or updates developed by the entity during the period will be made available because the entity stands ready to transfer updates or upgrades when and if they become available. The customer benefits from the guarantee evenly throughout the contract period because any updates or upgrades developed by the entity during the period will be made available. As a result, a time-based measure of progress over the period during which the customer has rights to any unspecified upgrades developed by the entity would generally be appropriate unless the entity’s historical experience suggests that another method would more faithfully depict the pattern of transfer of the when-and-if-available upgrades to the customer.
The determination of an appropriate measure of progress for
a stand-ready obligation is addressed in Implementation Q&A 49 (compiled from previously issued
TRG Agenda Papers 16 and 25). For additional information and Deloitte’s summary of
issues discussed in the Implementation Q&As, see Appendix C.
Once an entity has determined the nature of the promise to the
customer, the entity must determine how to appropriately recognize revenue. As
discussed in Section 8.1.1,
an entity must first go through steps 1 through 4 before applying step 5 to
determine when to recognize revenue. Specifically, an entity must identify the
nature of the promised goods and services and determine whether those goods and
services are distinct (as described in Chapter 5) before determining the appropriate
pattern of revenue recognition. For example, an entity may sell products through
a third-party distributor and implicitly or explicitly promise to provide a
stand-ready service to the end customer. In these situations, the entity should
begin to recognize revenue for a stand-ready service promised to a customer’s
customer when the end customer has the ability to access, and begin to consume
and benefit from, the service. In addition, as illustrated in Examples 8-9 and 8-10, the pattern of revenue
recognition may differ depending on the nature of the promised goods and
services in the contract. Therefore, it is critical that an entity carefully
assess the promised goods and services in the contract before jumping to revenue
recognition in step 5. In some instances, an entity may be providing a service
of standing ready to provide as many goods or services as needed by a customer
when called upon (i.e., a stand-ready obligation). However, in other instances,
an entity may be available to provide goods or services when called upon by a
customer, but the customer only has a right to a specified amount of goods or
services.
In the two examples below, Entity X enters into two different
contracts, one with Customer A and the other with Customer B, to provide cloud
computing capacity. Because of the nature of X’s business, very little
incremental effort is required as X’s customers use the cloud computing
capacity.
Example 8-9
Contract With
Customer A for a Specified Quantity
Entity X enters into a three-year
contract with A, under which A receives the right to a
specified quantity of cloud computing capacity on an “as
needed” basis. Unused capacity is forfeited at the end
of the contract term. On the basis of historical usage,
X does not expect A to use the cloud computing capacity
evenly through the contract term but expects A to use
all of the agreed capacity before the end of the
contract. Once A has used the specified quantity of
capacity, A no longer has the ability to use the
service, and additional capacity must be separately
negotiated.
As discussed in Section 5.4.3.2, for an
entity to distinguish between a stand-ready obligation
and an obligation to provide a defined amount of goods
or services, it will often be helpful to focus on the
extent to which the customer’s use of a resource affects
the remaining resources to which the customer is
entitled.
In the circumstances described, the
nature of X’s promise is to provide a fixed capacity,
and its performance under the contract is demonstrated
by the actual discrete delivery of capacity. In contrast
to the example in paragraph BC160 of ASU 2014-09 (see
Section
5.4.3.2), when A uses cloud computing
capacity, A’s usage does affect the amount of the
remaining services to which A is entitled, indicating
that X’s promise is to deliver specified services rather
than to stand ready.
As a result, X should recognize revenue
in a manner that is consistent with A’s usage of the
capacity during the reporting period (i.e., by applying
a usage-based measure of progress). It would not be
appropriate for X to recognize revenue by using a
ratable or straight-line method.
Example 8-10
Contract With
Customer B for an Unlimited Quantity
In contrast to X’s contract with A, X’s
contract with B is to provide unlimited cloud computing
capacity as required over a three-year term. Because X
has agreed to provide an unlimited quantity of cloud
computing capacity, the nature of X’s promise to B is to
continuously stand ready to make unlimited cloud
computing capacity available, and B’s entitlement to
future capacity is not affected by the extent to which B
already used capacity. In such circumstances,
straight-line revenue recognition might be an
appropriate representation of X’s transfer of control
for this stand-ready obligation. However, X should
consider information from similar contracts regarding
historical patterns of performance in using judgment to
select an appropriate measure of progress based on its
service of making the cloud computing capacity available
(which is not necessarily the same as when the customers
use the capacity made available to them).
Connecting the Dots
In some arrangements — specifically, arrangements
involving software as a service (SaaS) — it may not always be clear
whether the nature of the promise is (1) an obligation to provide a
specified amount of services (e.g., 5,000 transactions processed through
software provided as a service) or (2) a stand-ready obligation to
provide services when and if called upon (e.g., to process all of the
transactions required through SaaS). Sometimes in practice, an entity
may price a SaaS arrangement on the basis of volume expectations but may
still be required to stand ready to provide the service for the entire
contractual period regardless of whether the customer exceeds the
volumes expected at contract inception. In other cases, a customer’s
right to use the service may terminate once the initial volumes are
exceeded, or the contract would be modified once the volumes are
exceeded. In all of these circumstances, an entity will need to
carefully consider the contractual rights and obligations to
appropriately identify the nature of the promise and to determine an
appropriate measure of progress toward complete satisfaction of the
performance obligation.
Footnotes
2
Footnote 1 in TRG Agenda Paper 53
notes that as used in the discussion, “milestones” refer to
measures of progress (i.e., they correlate to an entity’s
performance toward complete satisfaction of a performance
obligation) rather than the “milestone method” under legacy
U.S. GAAP.
3
Quoted from paragraph 19 of TRG Agenda Paper
53.
4
Quoted from Implementation Q&A 51.
5
Quoted from Implementation Q&A 47.
6
Quoted from ASC 606-10-55-18.
7
Quoted from paragraph BC167 of ASU 2014-09.