Chapter 8 — Step 5: Determine When to Recognize Revenue

8.9 Other Considerations in Step 5

8.9.1 Transfer of Control in Licensing Arrangements

The FASB and IASB acknowledged that because of the intangible nature of licenses, license arrangements create unique challenges in the application of the revenue framework. For that reason, the boards provided within their implementation guidance some additional guidance on assessing license arrangements.

The application of the control-based model in the delivery of licenses requires a comprehensive understanding of the entity’s arrangement with a customer and an understanding of the type of intellectual property (IP) that is subject to the license agreement. A contract that includes a right to use software can be viewed as a contract for a good or a service. For example, software that relies on an entity’s IP and is delivered only through a hosting arrangement (i.e., the customer cannot take possession of the software) is a service, whereas a software arrangement that is provided through an access code or key is more like the transfer of a good. In light of these unique characteristics, the boards established the additional implementation guidance to assist in the assessment of how and when the entity transfers control of its IP through a license to the customer since that control is transferred over time in some cases and at a point in time in other cases.

In determining whether the transfer of a license occurs over time or at a point in time, an entity should consider the indicators of the transfer of control to determine the point in time at which a license is transferred to the customer. ASC 606-10-55-58C states that revenue from a license of IP cannot be recognized before both of the following:

An entity provides (or otherwise makes available) a copy of the intellectual property to the customer.
The beginning of the period during which the customer is able to use and benefit from its right to access or its right to use the intellectual property. That is, an entity would not recognize revenue before the beginning of the license period even if the entity provides (or otherwise makes available) a copy of the intellectual property before the start of the license period or the customer has a copy of the intellectual property from another transaction. For example, an entity would recognize revenue from a license renewal no earlier than the beginning of the renewal period.

Section 12.5 further explores transfer of control related to licensing arrangements.

8.9.2 Partially Satisfied Performance Obligations Before the Identification of a Contract

Entities sometimes begin activities on a specific anticipated contract with their customer before (1) the parties have agreed to all of the contract terms or (2) the contract meets the criteria in step 1 (see Chapter 4) of the revenue standard. The FASB and IASB staffs refer to the date on which the contract meets the step 1 criteria as the “contract establishment date” (CED) and refer to activities performed before the CED as “pre-CED activities.”

Sometimes, pre-CED activities result in the transfer of a good or service to an entity’s customer on the date the contract meets the criteria in ASC 606-10-25-1 (e.g., when the customer takes control of the partially completed asset) such that a performance obligation meeting the criteria in ASC 606-10-25-27 for recognition of revenue over time is partially satisfied.

Stakeholders have identified two issues with respect to pre-CED activities:

How to recognize revenue from pre-CED activities.
How to account for certain fulfillment costs incurred before the CED.

Once the criteria in step 1 have been met, entities should recognize revenue for pre-CED activities on a cumulative catch-up basis (i.e., record revenue as of the CED for all satisfied or partially satisfied performance obligations) rather than prospectively because cumulative catch-up is more consistent with the revenue standard’s core principle. On that date, the entity should recognize revenue on a cumulative catch-up basis that reflects the entity’s progress toward complete satisfaction of the performance obligation. In calculating the required cumulative catch-up adjustment, the entity should consider the requirements in ASC 606-10-25-23 through 25-37 with respect to determining when a performance obligation is satisfied to determine the goods or services that the customer controls on the date the criteria in ASC 606-10-25-1 are met.

Similarly, certain fulfillment costs incurred before the CED are capitalized as costs of fulfilling an anticipated contract. If other Codification topics are applicable to pre-CED fulfillment costs, an entity should apply the guidance in those other Codification topics. If it is determined that other Codification topics are not applicable, an entity should capitalize such costs as costs of fulfilling an anticipated contract, subject to the criteria in ASC 340-40-25-5. Once the criteria in step 1 have been met, the portion of the asset related to progress made to date should be expensed immediately. The remaining asset should be amortized over the period in which the related goods or services are transferred to the customer.

Costs that do not satisfy the criteria in other Codification topics or in ASC 340-40-25-5 for recognition as an asset (e.g., general and administrative costs that are not explicitly chargeable to the customer under the contract) should be expensed as incurred in accordance with ASC 340-40-25-8.

The above issues are addressed in Implementation Q&As 53 and 76 (compiled from previously issued TRG Agenda Papers 33 and 34). For additional information and Deloitte’s summary of issues discussed in the Implementation Q&As, see Appendix C.

Example 8-19

In this example, assume that the criteria for recognizing revenue over time are met. In practice, whether those criteria are met will depend on a careful evaluation of the facts and circumstances.

An entity is constructing a piece of specialized equipment to an individual customer’s specifications. Because of a delay in obtaining the customer’s approval for the contract, the entity commences work on constructing the equipment before the contract is signed. Consequently, the costs that meet the criteria in ASC 340-40-25-5 that the entity incurs in performing this work are initially capitalized. Subsequently, the contract is approved, and the terms of the contract are such that the criteria for recognition of revenue over time are met. On the date the contract is signed and the criteria in ASC 606-10-25-1 are met, a cumulative catch-up of revenue (and expensing of capitalized costs), reflecting progress made to date, should be recognized for the partially constructed equipment.

Example 8-20

In this example, assume that the criteria for recognizing revenue over time are met. In practice, whether those criteria are met will depend on a careful evaluation of the facts and circumstances.

An entity is constructing an apartment block, in a foreign jurisdiction, consisting of 10 apartments. In the period before commencing construction, the entity has signed contracts (meeting the criteria in ASC 606-10-25-1) with customers for six of the apartments in the apartment block but not for the remaining four. The entity uses standard contract terms for each apartment, such that the entity (1) is contractually restricted from readily directing the apartment for another use during its construction and (2) has an enforceable right to payment for performance completed to date.

For the six apartments for which contracts have been signed with customers, the construction of each apartment represents the transfer of a performance obligation over time because the criteria in ASC 606-10-25-27(c) are met. Accordingly, revenue is recognized as those six apartments are constructed, reflecting progress made to date, and the costs incurred in relation to those six apartments are expensed to the extent that they are related to progress made to date.

For the four apartments for which contracts have not yet been signed with customers, costs that meet the criteria in ASC 340-40-25-5 are initially capitalized. Subsequently, on the date a contract is signed with a customer for one of those four apartments and the criteria in ASC 606-10-25-1 are met, a cumulative catch-up of revenue (and expensing of related capitalized costs) should be recognized for that apartment.

There may be instances in which an entity has transferred goods or services to the customer but has not met the requirements of step 1 in ASC 606-10-25-1 (i.e., one of the five required criteria is not met). For example, the entity may not have met the criterion stating that “[i]t is probable that the entity will collect substantially all of the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer.” In these instances, the entity would generally not record a receivable (or a related contract liability) to reflect its right to payment for performance completed before meeting the step 1 criteria.

ASC 606-10-45-4 states, in part, the following:

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

Refer to Chapter 4 (step 1) for considerations related to whether an entity can account for a receivable before the contract existence criteria are met.

8.9.3 Trial Periods

In a manner consistent with the discussion in Section 4.3.1 on free trial periods, entities may need to consider the effect of trial periods on contracts with customers. An entity must evaluate whether a contract exists during a trial period and, if so, the appropriate timing of revenue recognition during the trial period. Factors to consider include whether the trial period is risk-free, whether the customer has an obligation to make further purchases beyond the trial period, and whether the goods or services transferred during the trial period are, in fact, performance obligations. This determination may require an entity to use judgment on the basis of the specific facts and circumstances of the arrangement.

Two types of trial periods that an entity may participate in to solicit customers are (1) “risk-free” trials (i.e., the customer is not committed to a contract until some of the goods or services are delivered) and (2) the delivery of “free” goods or services upon execution of a contract (i.e., a contract under the revenue standard exists when the free goods or services are delivered). As noted above, it is essential to evaluate whether a contract with a customer exists under the revenue standard to determine whether the goods or services provided during the trial period are performance obligations to which revenue should be allocated and recognized when control transfers. In addition, consideration should be given to whether the entity’s performance obligation to transfer the goods or services during the trial period is satisfied at a point in time or over time (i.e., partly during the trial period and partly during the contractual period). Such factors are likely to affect the determination of whether and, if so, when revenue is recognized for the goods or services provided during the trial period.

The two examples below illustrate the accounting for free goods or services.

Example 8-21

Risk-Free Magazines

Entity A sells sports magazines that customers are able to purchase on an annual subscription basis. Entity A’s marketing program includes a risk-free offer that allows a subscriber to receive a predefined number of magazine issues on a trial basis (but A is not obligated to provide any free magazines). For example, A will deliver up to 3 magazines on a trial basis, and upon the customer’s decision to accept the subscription offer, $12 is due and payable to A. Regardless of when the customer accepts the subscription offer during the trial period, A will deliver a total of 15 magazines (which includes the 3 “risk-free” magazines) in exchange for a nonrefundable fee of $12.

Assume that after A has delivered the first 2 trial-period magazines, the customer accepts the subscription offer and pays A a nonrefundable price of $12. Each magazine is determined to be a distinct performance obligation that is satisfied at a point in time.

The parties are not committed to perform their respective obligations until the customer accepts the subscription offer. That is, no contract exists. Once the customer accepts the offer (after 2 free magazines are delivered), A has a contract to deliver 13 additional magazines to the customer (the first 2 free magazines are a marketing offer rather than a promised good or service). Entity A would allocate the $12 transaction price to the 13 magazines (92¢ each) and recognize revenue as each magazine is transferred to the customer.

Example 8-22

Bonus Magazines

Entity A offers a marketing program that advertises that bonus magazines will be added to a subscription term. For example, upon a customer’s acceptance of an offer for an annual magazine subscription, A will supply three bonus months that result in a total of 15 magazines. Accordingly, if a customer accepts a subscription offer, the customer will receive 15 magazines for an annual nonrefundable subscription price of $12.

Once the customer accepts the subscription offer, the nature of the promise is to transfer 15 magazines to the customer for $12. Entity A would allocate the transaction price to each of the 15 magazines (80¢ per magazine) and recognize revenue as each magazine is transferred to the customer.

8.9.4 Up-Front Fees

Arrangements may include up-front fees (e.g., activation fees or nonrefundable deposits) before any goods or services are transferred to the customer. Entities must determine whether any goods or services are transferred in exchange for the up-front fee, or whether the transfer of goods or services has not yet commenced.

When up-front fees are included in an arrangement, an entity must first identify the performance obligations (see Section 5.6 for additional discussion about determining the nature of a promise and identifying performance obligations). Any up-front payment becomes a portion of the overall transaction price (see Chapter 6 for further discussion about determining the transaction price).

When an entity enters into a contract with a customer, it sometimes receives some or all of the consideration up front, before transferring the promised goods or services to the customer (i.e., before satisfying the performance obligation). In these circumstances, the up-front fee cannot be recognized as revenue immediately when it is received.

Under ASC 606, the timing of recognition of revenue is not based on cash receipt or payment schedules. Instead, an entity recognizes revenue when (or as) it satisfies a performance obligation by transferring control of a promised good or service to a customer.

When an entity receives consideration before the related performance obligation is satisfied, the entity should not recognize the advance payment as revenue until that obligation is satisfied. However, the entity should recognize the consideration received as a contract liability (i.e., deferred revenue) in its statement of financial position and evaluate such payment for the potential existence of a significant financing component (see Section 6.4).

This treatment is required even if the consideration received up front is nonrefundable since the goods or services may not have been transferred to the customer. Specifically, ASC 606-10- 55-51 states, in part:

In many cases, even though a nonrefundable upfront fee relates to an activity that the entity is required to undertake at or near contract inception to fulfill the contract, that activity does not result in the transfer of a promised good or service to the customer . . . . Instead, the upfront fee is an advance payment for future goods or services and, therefore, would be recognized as revenue when those future goods or services are provided.

Further, ASC 606-10-55-53 states, in part:

An entity may charge a nonrefundable fee in part as compensation for costs incurred in setting up a contract (or other administrative tasks as described in paragraph 606-10-25-17). If those setup activities do not satisfy a performance obligation, the entity should disregard those activities (and related costs) when measuring progress in accordance with paragraph 606-10-55-21. That is because the costs of setup activities do not depict the transfer of services to the customer.

The example below illustrates how to determine whether a nonrefundable initiation fee in a club membership contract should be recognized upon receipt.

Example 8-23

An entity operates a fitness club. The key terms of its contractual arrangements with customers are as follows:

Customers have to pay an initiation fee of $100 upon entering into the contract.
Each contract has a term of one year. During the contractual period, customers are required to pay a monthly fee of $100 (irrespective of their usage of the club during that month).
The initiation fee is not refundable, even if the customer never uses the club during the one-year contract period.

The entity should not recognize the initiation fee as revenue upon receipt even though it is nonrefundable. Under ASC 606, an entity should recognize revenue when (or as) it satisfies a performance obligation by transferring a promised good or service to a customer.

In this example, customers pay the initiation fee and monthly fees to use the facilities provided by the fitness club. The performance obligation is therefore to provide fitness club facilities for customers’ use. Hence, the initiation fee is just part of the consideration paid by customers to use the facilities in the future. Because no performance obligation has been satisfied upon payment of that fee, revenue should not be recognized immediately in profit or loss when that consideration is received.

Instead, the initiation fee should be recognized as a liability. Such consideration would be included in the transaction price and recognized as revenue when (or as) the entity satisfies the associated performance obligations, which may include a material right.

8.9.5 Recognizing Revenue Related to Commissions Earned by a Sales Agent

An entity may earn revenue in the form of a sales commission; the treatment of sales commissions (i.e., the timing of recognizing the revenue related to the sales commission) may vary depending on the terms of the arrangement. In some cases in which an entity acts as an agent, it is providing a service over time; however, in other instances, an agent only provides its service at a point in time. See Chapter 10 for further discussion of principal-versus-agent considerations.

The timing of recognition of a sales agent’s commission revenue depends on the nature of (1) the agreement between the sales agent and its customer (the principal) and (2) the promise to the customer. Revenue will be recognized at a point in time unless the criteria in ASC 606-10-25-27 are met. Accordingly, it is appropriate to focus on ASC 606-10-25-27(a) and (c):

Does the principal simultaneously receive and consume the benefits provided by the sales agent’s performance as the sales agent performs?
Does the sales agent have an enforceable right to payment for performance completed to date?

In accordance with ASC 606-10-55-6, when the first of these criteria is assessed, it will be appropriate to consider whether another entity would need to substantially reperform the work that the sales agent has completed to date if that other entity were to fulfill the remaining performance obligation to the principal.

Often, the only promise that a sales agent makes to the principal is to arrange a sale, and the sales agent is only paid commission if it achieves a sale. In these circumstances, the criterion in 606-10-25-27(a) will typically not be met. That is, as the agent works toward achieving a sale (e.g., by meeting with the principal’s potential customer), the work performed is not consumed by the principal (i.e., the agent’s customer) until a sale is achieved. Further, if another entity were to take over from the sales agent, typically that other entity would need to substantially reperform the work that the sales agent has completed to date (e.g., reestablish contact and build a relationship with the principal’s potential customer). Thus, the conditions for recognizing revenue over time are not met, and control of the “good or service” is not considered to be transferred. In these instances, the point in time at which revenue should be recognized will depend on the nature of the sales agent’s promise to its customer, the principal. The agent may perform activities before a sale, but these activities are often performed on the agent’s own behalf to fulfill the promise made to the customer, which is to complete the sale. Although there may be some limited benefit to the customer as a result of the sales agent’s presale activities, that benefit is significantly limited unless a sale transaction is ultimately completed.

This conclusion is consistent with Example 45 of the revenue standard (ASC 606-10-55-317 through 319), which concludes that “[w]hen the entity satisfies its promise to arrange for the goods to be provided by the supplier to the customer (which, in this example, is when goods are purchased by the customer), the entity recognizes revenue in the amount of the commission to which it is entitled.” The use of the word “when” suggests that this is at a point in time, whereas the use of the word “as” would have implied that the entity is delivering, and the customer is receiving, a good or service over time.

In some instances, a sales agent may receive nonrefundable consideration at the outset of an arrangement, which may indicate that the customer is receiving a benefit from the activities performed before the sale. That is, the agent in these circumstances may be delivering an additional service during the contractual period (e.g., a listing service). However, the mere existence of such an up-front payment does not in itself indicate that a good or service has been transferred before the ultimate sale. In all cases, careful consideration of the contractual arrangement is required, and revenue should be recognized over time only if the contract meets one of the criteria in ASC 606-10-25-27.

Example 8-24

Revenue Recognized Upon Completion of the Sale

A sales agent enters into an arrangement with a seller in which it promises to arrange for buyers to purchase the seller’s products. The agent performs various tasks to locate a buyer, including listing the products on its Web site. Once a buyer is located, the agent facilitates the purchase of the product on its Web site. The agent receives a commission equal to 10 percent of the sales price of the product when a sale is completed. The seller also pays the agent a small up-front fee to help cover costs incurred by the agent before the sale. The up-front fee is nonrefundable (i.e., the sales agent retains the fee even if the product is not sold). The up-front fee is expected to represent approximately 5 percent of the contract consideration received by the agent, and the commission represents the remaining 95 percent.

In this example, the promise to the customer is to arrange for the sale; therefore, the performance obligation is satisfied at the time of the sale. The agent should recognize the up-front fee and commission at the point in time when the sale is completed (as discussed above, the point in time at which revenue should be recognized will depend on the nature of the promise to the customer). The listing service in this example is an activity that the agent performs to satisfy its promise (i.e., to achieve the sale), but it does not transfer a good or service to the customer.

Example 8-25

Revenue Recognized Over Time

A sales agent enters into an arrangement with a seller in which it promises to list the seller’s products on its Web site for a specified period in a manner similar to that of an online classified ad. If a buyer decides to purchase the seller’s product, the buyer separately contacts the seller to complete the transaction. The agent receives a fee from the seller for the listing service. This fee is nonrefundable even if the product is not sold. If the product is sold, the agent also receives a commission equal to 1 percent of the sales price of the product. The listing fee is expected to represent approximately 80 percent of the contract consideration received by the agent, and the commission represents the remaining 20 percent.

In this example, the promise to the customer is the listing service. This performance obligation is satisfied over time as the customer receives the benefit of the listing (the customer simultaneously receives and consumes the benefit). Therefore, the agent should recognize the contract consideration over the listing period. The significant up-front payment is one indicator that the promise to the customer in this example is the listing service (as opposed to a promise to arrange for a sale, as in the example above). The commission represents variable consideration that the agent should estimate (unless the variable consideration meets the criteria in ASC 606-10-32-40 to be allocated to the period in which the product sale occurs) and include in the transaction price, subject to the constraint.

Example 8-26

Two Separate Performance Obligations

A sales agent manages a Web site that (1) lists independent sellers’ products and (2) posts advertisements of independent sellers’ products. Advertisements are purchased by some of the sales agent’s customers on a stand-alone basis (i.e., they are purchased by customers that do not have any products listed on the Web site) and by other customers of the sales agent that are also contracting to have their products listed for sale on the Web site.

The sales agent enters into an arrangement with a seller in which it promises to arrange for buyers to purchase the seller’s products. The products are listed on the agent’s Web site, and potential buyers are able to search for and view the products. In addition, the agent agrees to advertise the product on its Web site for a fixed price per day based on the length or content of the advertisement (e.g., number of words, pictures). The seller also purchases optional “upgrade” features for an additional fee, such as premium placement of the advertisement. The seller determines the number of days to run the advertisement and the content of the advertisement. The fees for the advertisement are nonrefundable even if the product is not sold. Once a buyer is located, the agent facilitates the purchase of the product on its Web site. The agent receives a commission equal to 5 percent of the sales price of the product when a sale is completed. The nonrefundable fee for the advertisement is expected to represent approximately 50 percent of the contract consideration received by the agent, and the commission represents the remaining 50 percent.

In this example, there are two distinct promises to the customer: the advertisement and the promise to arrange for the sale. The promises are distinct because the purchase of the advertisement is optional and the seller could sell its product on the Web site without the advertisement. The agent also sells advertisements separately to other customers. The advertising service is satisfied over time because the customer simultaneously receives and consumes the benefit over the period the advertisement is run. The promise to arrange for the sale is satisfied at the time of sale. The agent should estimate the total consideration, including the variable consideration (subject to the constraint) and allocate the consideration to the two performance obligations on the basis of stand-alone selling prices. Alternatively, if both the contract price for the advertisement and the price for arranging the sale reflect their respective stand-alone selling prices, the entity may not need to estimate the variable consideration.

If the promises were not considered distinct, the combined performance obligation may be satisfied over time (for the same reasons the advertising service is satisfied over time when it is distinct). The agent would determine the estimated transaction price, including variable consideration subject to the constraint (unless the variable consideration meets the criteria in ASC 606-10-32-40 to be allocated to the period in which the product sale occurs), and recognize revenue by using an appropriate measure of progress.

8.9.6 Government Vaccine Stockpile Programs

In August 2017, the SEC issued an interpretive release (the “2017 release”) updating the Commission’s previous guidance on accounting for sales of vaccines and bioterror countermeasures to the federal government for placement into stockpiles related to the Vaccines for Children Program or the Strategic National Stockpile. The update was aimed at conforming the SEC’s guidance with ASC 606.

Under the guidance in the 2017 release, vaccine manufacturers should recognize revenue when vaccines are placed into U.S. government stockpile programs because control of the vaccines has been transferred to the customer. However, these entities also need to evaluate whether storage, maintenance, or other promised goods or services associated with vaccine stockpiles are separate performance obligations. The guidance in the 2017 release applies only to the stockpile programs discussed in that release and is not applicable to any other transactions.

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