9.2 Types of Contract Modifications

If a change in a contract qualifies as a contract modification under ASC 606-10-25-10 and 25-11, the entity must assess the goods and services and their selling prices. Depending on whether those goods and services are distinct or sold at their stand-alone selling prices, a modification can be accounted for as:

A separate contract (see ASC 606-10-25-12).
One of the following (if the modification is not accounted for as a separate contract):
- A termination of the old contract and the creation of a new contract (see ASC 606-10-25-13(a)).
- A cumulative catch-up adjustment to the original contract (see ASC 606-10-25-13(b)).
- A combination of the items described in ASC 606-10-25-13(a) and (b), in a way that faithfully reflects the economics of the transaction (see ASC 606-10-25-13(c)).

The flowchart below explains the decisions needed to (1) identify modifications made to a contract and (2) determine how an entity should account for each type of contract modification.

If the answer is “Yes” for some goods or services and “No” for others, it may be appropriate to apply both models to a single contract, in the manner described in ASC 606-10-25-13(c), on the basis of an assessment at the performance obligation level. See Section 9.2.2.

For illustrative examples, see Example 9-3; ASC 606-10, Examples 8 and 9; and Example 9-7.

For illustrative examples, see Example 9-2; ASC 606-10, Example 5, Case B; ASC 606-10, Example 7; Example 9-6; Example 9-8; and ASC 606-10, Example 6

For an illustrative example, see ASC 606-10, Example 5, Case A.

9.2.1 Contract Modification Accounted for as a Separate Contract

ASC 606-10

25-12 An entity shall account for a contract modification as a separate contract if both of the following conditions are present:

The scope of the contract increases because of the addition of promised goods or services that are distinct (in accordance with paragraphs 606-10-25-18 through 25-22).
The price of the contract increases by an amount of consideration that reflects the entity’s standalone selling prices of the additional promised goods or services and any appropriate adjustments to that price to reflect the circumstances of the particular contract. For example, an entity may adjust the standalone selling price of an additional good or service for a discount that the customer receives, because it is not necessary for the entity to incur the selling-related costs that it would incur when selling a similar good or service to a new customer.

When an entity accounts for a contract modification as a separate contract in accordance with ASC 606-10-25-12, the entity’s accounting for the original contract is not affected by the modification. Any revenue recognized through the date of the modification is not adjusted, and remaining performance obligations will continue to be accounted for under the original contract. The new contract is accounted for separately from the original contract and on a prospective basis.

There is no economic difference between (1) a modification of an existing contract with a customer that includes additional distinct goods or services at their representative stand-alone selling prices and (2) a completely new contract entered into by the two parties for goods or services at their representative stand-alone selling prices. Therefore, a modification of an existing contract should be accounted for as a new contract that is separate and apart from the existing contract when (1) there are additional distinct goods or services promised to a customer and (2) those goods or services are in exchange for consideration that represents the stand-alone selling prices of the additional distinct promised goods or services. The change in scope must be an increase rather than a decrease in the quantity of promised goods or services because by its very nature, a new contract that decreases the quantity of goods or services promised in the original contract is inherently modifying the original contract (i.e., the new contract is not separate).

When considering whether the price charged to the customer represents the stand-alone selling prices of additional distinct promised goods or services, entities are allowed to adjust the stand-alone selling prices to reflect a discount for costs they do not incur because they have modified a contract with an existing customer. For example, the renewal price that an entity charges a customer is sometimes lower than the initial price because the entity recognizes that the expenses associated with obtaining a new customer can be excluded from the renewal price to provide a discount to the existing customer. This lower renewal price may reflect the stand-alone selling prices of additional distinct goods or services provided in the renewed contract. See Section 7.3 for a discussion of the guidance on determining stand-alone selling prices and Section 7.6 for a discussion of the guidance on changes in the transaction price.

Connecting the Dots

If a modification is accounted for as a separate contract in accordance with ASC 606-10-25-12, the original contract is treated as unmodified for the purposes of ASC 606. However, if a contract modification does not qualify for the accounting under ASC 606-10-25-12, determining how to account for the modification can be more challenging.

For example, assume that Company X has entered into a contract to provide a customer with 100 units of Product A over 10 years. Five years into the term of the original contract, the contract is modified by agreement of the parties to provide the customer with an additional 25 units of Product B at Product B’s stand-alone selling price. In addition, both products are capable of being distinct and are distinct within the context of the contract. Therefore, on the basis of these two factors, the modification would be treated as a separate contract.

In contrast, assume that X agrees to provide the customer with 25 more units of Product A instead of Product B. The additional units are the same as the previous Product A provided to the customer. Company X would have to determine as of the date of the modification whether it is selling the additional units of Product A at their stand-alone selling price at the time of the modification. As previously mentioned, five years have passed between the original contract and the modification. Assuming that the price of Product A has changed over this time, X has to determine the stand-alone selling price of the additional goods to be delivered at the date of the modification to determine how to account for the modification. Specifically, if the additional goods are being sold at their then-current stand-alone selling price, the modification would represent a separate contract to be accounted for in accordance with ASC 606-10-25-12; but if the additional goods are not being sold at their then-current stand-alone selling price, the modification would be accounted for as a termination of the existing contract and the creation of a new contract in accordance with ASC 606-10-25-13(a).

The following example in ASC 606 illustrates an entity’s assessment of whether a contract modification represents a separate contract:

ASC 606-10

Example 5 — Modification of a Contract for Goods

55-111 An entity promises to sell 120 products to a customer for $12,000 ($100 per product). The products are transferred to the customer over a six-month period. The entity transfers control of each product at a point in time. After the entity has transferred control of 60 products to the customer, the contract is modified to require the delivery of an additional 30 products (a total of 150 identical products) to the customer. The additional 30 products were not included in the initial contract.

Case A — Additional Products for a Price That Reflects the Standalone Selling Price

55-112 When the contract is modified, the price of the contract modification for the additional 30 products is an additional $2,850 or $95 per product. The pricing for the additional products reflects the standalone selling price of the products at the time of the contract modification, and the additional products are distinct (in accordance with paragraph 606-10-25-19) from the original products.

55-113 In accordance with paragraph 606-10-25-12, the contract modification for the additional 30 products is, in effect, a new and separate contract for future products that does not affect the accounting for the existing contract. The entity recognizes revenue of $100 per product for the 120 products in the original contract and $95 per product for the 30 products in the new contract.

9.2.2 Contract Modification Not Accounted for as a Separate Contract

ASC 606-10

25-13 If a contract modification is not accounted for as a separate contract in accordance with paragraph 606-10-25-12, an entity shall account for the promised goods or services not yet transferred at the date of the contract modification (that is, the remaining promised goods or services) in whichever of the following ways is applicable:

An entity shall account for the contract modification as if it were a termination of the existing contract, and the creation of a new contract, if the remaining goods or services are distinct from the goods or services transferred on or before the date of the contract modification. The amount of consideration to be allocated to the remaining performance obligations (or to the remaining distinct goods or services in a single performance obligation identified in accordance with paragraph 606-10-25-14(b)) is the sum of:
1. The consideration promised by the customer (including amounts already received from the customer) that was included in the estimate of the transaction price and that had not been recognized as revenue and
2. The consideration promised as part of the contract modification.
An entity shall account for the contract modification as if it were a part of the existing contract if the remaining goods or services are not distinct and, therefore, form part of a single performance obligation that is partially satisfied at the date of the contract modification. The effect that the contract modification has on the transaction price, and on the entity’s measure of progress toward complete satisfaction of the performance obligation, is recognized as an adjustment to revenue (either as an increase in or a reduction of revenue) at the date of the contract modification (that is, the adjustment to revenue is made on a cumulative catch-up basis).
If the remaining goods or services are a combination of items (a) and (b), then the entity shall account for the effects of the modification on the unsatisfied (including partially unsatisfied) performance obligations in the modified contract in a manner that is consistent with the objectives of this paragraph.

A contract modification that does not meet the requirements outlined in Section 9.2.1 is not accounted for as a separate contract. Therefore, an entity would have to determine how to account for a blended contract that now includes one or both of the following:

An original agreement plus or minus other goods or services.
A change in the amount of consideration due under the modified arrangement.

The determination of which model to use depends on whether the remaining goods or services (the originally promised items and the newly promised items) are distinct from the goods and services already provided under the contract.

In accordance with ASC 606-10-25-13(a), if the remaining goods or services are distinct from the goods or services already provided under the original arrangement, the entity would in effect establish a “new” contract that includes only those remaining goods and services. In this situation, the entity would allocate to the remaining performance obligations (or distinct goods or services) in the contract (1) consideration from the original contract that has not yet been recognized as revenue and (2) any additional consideration from the modification. Such a situation would arise when there is a modification to a contract that contains (1) remaining distinct performance obligations or (2) a single performance obligation accounted for as a series of distinct goods or services under ASC 606-10-25-14(b) (see Section 5.3.3).

In contrast, in accordance with ASC 606-10-25-13(b), if the contract modification results in remaining goods and services that are not distinct, the entity should account for the modification as though the additional goods and services were an addition to an incomplete performance obligation. This may be the case in a situation involving a construction-type contract to build a single complex when the original contract includes certain specifications and, as the construction progresses, the parties modify the terms to change certain requested features of the complex. In this instance, a measure of progress would typically be used to recognize revenue over time. For example, suppose that just before the modification, the entity’s performance was 30 percent complete. After the modification, the entity may determine that its performance is only 25 percent complete because the scope of the single performance obligation increased (or is 35 percent complete because the scope of the single performance obligation decreased). As a result, an updated revenue figure is calculated on the basis of the revised percentage, and the entity would record a cumulative catch-up adjustment.

The FASB and IASB recognized that there may be contracts in which some performance obligations include remaining goods or services that are distinct from the goods or services already provided under the original arrangement, while other performance obligations include remaining goods and services that are not (i.e., a change in scope of a partially satisfied performance obligation). The boards decided that in those circumstances, it may be appropriate for an entity to apply both models to a single contract, in the manner described in ASC 606-10-25-13(c), on the basis of an assessment at the performance obligation level. An entity would do so by considering whether, for the performance obligations that are not yet fully satisfied (including those that are partially satisfied), the remaining goods or services to be transferred in accordance with the promise are distinct from the goods or services previously transferred. No change would be made to revenue recognized for fully satisfied performance obligations.

9.2.2.1 Repetitive Versus Accumulating Performance Obligations

Contract modifications will have different accounting implications for different types of performance obligations (i.e., repetitive or accumulating). An example of a repetitive performance obligation would be an entity’s promise to deliver the same good or service to a customer numerous times over an agreed-upon period, such as a performance obligation that meets the definition of a series in ASC 606-10-25-14(b). An example of an accumulating performance obligation would be a promise to perform many different procedures or activities over time to produce the final good or service to be provided to a customer, such as a performance obligation treated under ASC 606-10-25-14(a) as a bundle of goods or services that is distinct.

The example below illustrates how an entity would account for a modification of a repetitive performance obligation that meets the requirements of ASC 606-10-25-13(a).

Example 9-2

Modification of a Repetitive Performance Obligation

Company A has a contract with Customer B to provide 10 widgets at $10 per widget. The $10 represents the stand-alone selling price of the widget. Customer B pays A the full consideration amount of $100 up front. These widgets will be delivered to B over five years. Company A concludes that the performance obligation to deliver 10 widgets over five years qualifies for revenue recognition over time and meets the definition of a series in ASC 606-10-25-14(b). Assume that the contract does not have a significant financing component.

After three years, 5 widgets have been delivered to B (and revenue of $50 has been recognized), but B decides that it wants an additional 15 widgets (a total of 25 widgets). Company A agrees to sell the additional 15 widgets to B for $4 per widget. This price does not represent the stand-alone selling price of the widgets, and it is adjusted by more than the normal expenses that A would incur to obtain a new customer. In addition, the widgets are produced sequentially, and B’s request for additional widgets occurs immediately after delivery of the 5th widget but before production of the remaining widgets begins.

If each of the widgets in the original contract were determined to be distinct (see Chapter 5 for further analysis), A would apply the guidance in ASC 606-10-25-13(a) to this fact pattern because the remaining widgets are also distinct goods but are not sold at their stand-alone selling price. Therefore, A would reallocate the remaining consideration of both the original contract ($50) and the modification ($60) to the remaining performance obligations. In this example, A would allocate $110 across the remaining 20 widgets. As each widget is delivered, $5.50 would be recognized as revenue for A.

In contrast to the example above, the example below illustrates how an entity would account for a modification of an accumulating performance obligation accounted for under ASC 606-10-25-13(b).

Example 9-3

Modification of an Accumulating Performance Obligation

Assume that the original contract in the example above was determined to contain a single performance obligation that included an extensive and highly customized integration service that in effect reworked each widget as additional widgets were developed. Therefore, Company A identified a single performance obligation to deliver to Customer B a complete solution (that includes the original 10 widgets). Also assume that (1) revenue in the fact pattern is being recognized over time in accordance with ASC 606-10-25-27 and (2) as of the date of modification, but before the contract is actually modified, A has concluded that the contract is 40 percent complete. Company A has determined that the additional 15 widgets are not distinct from the original 10 widgets and that together, both sets of widgets still form a complete solution (a single project) that is being delivered to the customer.

Under these new facts, A would combine the goods and services from the original contract and the modification to the contract. No allocation is necessary since there is only a single performance obligation. However, A would need to determine the extent to which it has completed its modified performance obligation.

Assume that A determines that the modified performance obligation is now 20 percent complete. Further assume that before the modification, A recorded $40 of revenue ($100 × 40%). Upon modification, A would record an entry to reduce revenue by $8 ($160 × 20%, or $32, less $40) to catch up on previously recognized revenue to represent A’s performance to date on the basis of the modified contract terms and in accordance with ASC 606-10-25-13(b). Subsequently, A would recognize the remaining $128 ($160 − $32) as it completely satisfies the remaining performance obligation.

The table below lays out the facts of these two examples side by side for comparison.

	Fact Pattern 1 (Repetitive)	Fact Pattern 2 (Accumulating)
Contract length	January 1, 2015, through December 31, 2020	January 1, 2015, through December 31, 2020
Original obligation	Deliver 10 distinct widgets	Integrate 10 widgets into one complete solution (i.e., one performance obligation)
Consideration	$10 per widget	$100 for integration
Modification date	January 1, 2018	January 1, 2018
Performance completed to date	5 widgets delivered	40% integrated
Total remaining consideration	$50	$60
Additional goods and services	Deliver 15 additional distinct widgets	Integrate 15 additional widgets into one complete solution (i.e., one performance obligation)
Price for additional goods and services	$4 per widget	$4 per widget
Total additional consideration	$60	$60
Are the additional goods and services both capable of being distinct and distinct in the context of the contract?	Yes	No
Additional goods and services at stand-alone selling price?	No	No
Applicable modification guidance	ASC 606-10-25-13(a)	ASC 606-10-25-13(b)
Cumulative catch-up?	No	Yes
Cumulative catch-up amount	N/A	($100 + $60) × 20% = $32 $100 × 40% = $40 Cumulative catch-up = –$8
Consideration to recognize prospectively	(5 × $10) + (15 × $4) = $110 10 – 5 + 15 = 20 Revenue per widget = $5.50	$128 recognized as remaining performance obligation is satisfied

These two examples, which each involve a single performance obligation, demonstrate the difference in accounting for a contract modification when that single performance obligation either (1) represents a series of distinct goods or services that are substantially the same and have the same pattern of transfer to the customer or (2) represents a combined performance obligation because the bundle of goods or services either (a) is not capable of being distinct or (b) is not distinct within the context of the contract. When the remaining goods or services to be transferred are distinct, the entity will, in effect, terminate the original contract and establish a “new” contract (i.e., prospectively). When the remaining goods or services to be transferred are not distinct, the subsequent accounting for an identified contract modification will be, in effect, an adjustment (through a cumulative catch-up) to the original contract.

Contract modification accounting is heavily dependent on whether the remaining goods or services to be transferred are distinct from goods or services transferred before the modification. This further highlights the importance of appropriately identifying all distinct performance obligations in a contract, including an assessment of whether one or more performance obligations in a contract are required to be accounted for as a series in accordance with ASC 606-10-25-14(b). Contract modifications are evaluated at the performance obligation level unless the performance obligation is accounted for as a series, in which case contract modifications are evaluated at the level of the distinct goods or services that make up the series, as illustrated above. See Chapter 5 for a detailed discussion of the identification of performance obligations in a contract, including the requirement to identify as a performance obligation each promise to transfer to a customer a series of distinct goods or services that are substantially the same and have the same pattern of transfer to the customer.

The following examples in ASC 606 further illustrate a modification of a contract that contains a repetitive performance obligation (Example 7) and a modification of a contract that contains an accumulating performance obligation (Example 8):

ASC 606-10

Example 7 — Modification of a Services Contract

55-125 An entity enters into a three-year contract to clean a customer’s offices on a weekly basis. The customer promises to pay $100,000 per year. The standalone selling price of the services at contract inception is $100,000 per year. The entity recognizes revenue of $100,000 per year during the first 2 years of providing services. At the end of the second year, the contract is modified and the fee for the third year is reduced to $80,000. In addition, the customer agrees to extend the contract for 3 additional years for consideration of $200,000 payable in 3 equal annual installments of $66,667 at the beginning of years 4, 5, and 6. The standalone selling price of the services for years 4 through 6 at the beginning of the third year is $80,000 per year. The entity’s standalone selling price at the beginning of the third year, multiplied by the additional 3 years of services, is $240,000, which is deemed to be an appropriate estimate of the standalone selling price of the multiyear contract.

55-126 At contract inception, the entity assesses that each week of cleaning service is distinct in accordance with paragraph 606-10-25-19. Notwithstanding that each week of cleaning service is distinct, the entity accounts for the cleaning contract as a single performance obligation in accordance with paragraph 606-10- 25-14(b). This is because the weekly cleaning services are a series of distinct services that are substantially the same and have the same pattern of transfer to the customer (the services transfer to the customer over time and use the same method to measure progress — that is, a time-based measure of progress).

55-127 At the date of the modification, the entity assesses the additional services to be provided and concludes that they are distinct. However, the price change does not reflect the standalone selling price.

55-128 Consequently, the entity accounts for the modification in accordance with paragraph 606-10-25-13(a) as if it were a termination of the original contract and the creation of a new contract with consideration of $280,000 for 4 years of cleaning service. The entity recognizes revenue of $70,000 per year ($280,000 ÷ 4 years) as the services are provided over the remaining 4 years.

Example 8 — Modification Resulting in a Cumulative Catch-Up Adjustment to Revenue

55-129 An entity, a construction company, enters into a contract to construct a commercial building for a customer on customer-owned land for promised consideration of $1 million and a bonus of $200,000 if the building is completed within 24 months. The entity accounts for the promised bundle of goods and services as a single performance obligation satisfied over time in accordance with paragraph 606-10-25-27(b) because the customer controls the building during construction. At the inception of the contract, the entity expects the following:

55-130 At contract inception, the entity excludes the $200,000 bonus from the transaction price because it cannot conclude that it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur. Completion of the building is highly susceptible to factors outside the entity’s influence, including weather and regulatory approvals. In addition, the entity has limited experience with similar types of contracts.

55-131 The entity determines that the input measure, on the basis of costs incurred, provides an appropriate measure of progress toward complete satisfaction of the performance obligation. By the end of the first year, the entity has satisfied 60 percent of its performance obligation on the basis of costs incurred to date ($420,000) relative to total expected costs ($700,000). The entity reassesses the variable consideration and concludes that the amount is still constrained in accordance with paragraphs 606-10-32-11 through 32-13. Consequently, the cumulative revenue and costs recognized for the first year are as follows:

55-132 In the first quarter of the second year, the parties to the contract agree to modify the contract by changing the floor plan of the building. As a result, the fixed consideration and expected costs increase by $150,000 and $120,000, respectively. Total potential consideration after the modification is $1,350,000 ($1,150,000 fixed consideration + $200,000 completion bonus). In addition, the allowable time for achieving the $200,000 bonus is extended by 6 months to 30 months from the original contract inception date. At the date of the modification, on the basis of its experience and the remaining work to be performed, which is primarily inside the building and not subject to weather conditions, the entity concludes that it is probable that including the bonus in the transaction price will not result in a significant reversal in the amount of cumulative revenue recognized in accordance with paragraph 606-10-32-11 and includes the $200,000 in the transaction price. In assessing the contract modification, the entity evaluates paragraph 606-10-25-19(b) and concludes (on the basis of the factors in paragraph 606-10-25-21) that the remaining goods and services to be provided using the modified contract are not distinct from the goods and services transferred on or before the date of contract modification; that is, the contract remains a single performance obligation.

55-133 Consequently, the entity accounts for the contract modification as if it were part of the original contract (in accordance with paragraph 606-10-25-13(b)). The entity updates its measure of progress and estimates that it has satisfied 51.2 percent of its performance obligation ($420,000 actual costs incurred ÷ $820,000 total expected costs). The entity recognizes additional revenue of $91,200 [(51.2 percent complete × $1,350,000 modified transaction price) – $600,000 revenue recognized to date] at the date of the modification as a cumulative catch-up adjustment.

9.2.2.2 Blend-and-Extend Contract Modifications

9.2.2.2.1 Blend-and-Extend Contract Modifications in the Power and Utilities Industry

A common transaction in the power and utilities (P&U) industry, a blend-and-extend (B&E) contract modification refers to an agreement between an entity and a customer that are already in a contract to change the amount of consideration to be paid and extend the length of the contract term.

For B&E contract modifications, stakeholders have questioned how the payment terms affect the evaluation of the contract modification (i.e., whether the modification should be accounted for as a separate contract or a termination of the existing contract and the creation of a new contract). In a typical B&E modification, the supplier and customer may renegotiate the contract to allow the customer to take advantage of lower commodity pricing while the supplier increases its future delivery portfolio. Under such circumstances, the customer and supplier agree to extend the contract term and “blend” the remaining original, higher contract rate with the lower market rate of the extension period for the remainder of the combined term. The supplier therefore defers the cash realization of some of the contract fair value that it would have received under the original contract terms until the extension period, at which time it will receive an amount that is greater than the market price for the extension- period deliveries as of the date of the modification.

For example, a supplier and a customer enter into a fixed-volume, five-year forward sale of electricity at a fixed price of $50 per unit. Years 1 through 3 have passed, and both parties have met all of their performance and payment obligations for those years.

At the beginning of year 4, the customer approaches the supplier and asks for a two-year contract extension, stretching the remaining term to four years. Electricity prices have gone down since the original agreement was executed; as a result, a fixed price for the two-year extension period is $40 per unit based on forward market price curves that exist at the beginning of year 4. The customer would like to negotiate a lower rate now while agreeing to extend the term of the original deal.

The supplier and customer agree to a B&E contract modification. Under the modification, the $50-per-unit fixed price from the original contract with two years remaining is blended with the $40-per-unit fixed price for the two-year extension period. The resulting blended rate for the four remaining delivery years is $45 per unit.

There has been uncertainty about whether the supplier should compare (1) the net increase in the contract consideration (i.e., the total increase in consideration that the entity expects to be entitled to under the modified contract, including any changes to the prices of the remaining goods or services in the original contract) with the total stand-alone selling price of the goods or services added during the extension period or (2) the revised blended price the customer will pay for the additional goods or services (i.e., the $45-per-unit blended price paid for the goods or services delivered during the extension period) with the stand-alone selling price of those goods or services. In addition, the total transaction price may need to be reevaluated because the blending of the prices may create a significant financing component under the view that some of the consideration for the current goods or services is paid later as a result of the blending of the price for the remainder of the combined term.

The AICPA’s P&U industry task force originally added this item to its agenda. However, it was unable to reach a consensus on whether a B&E contract modification should be accounted for as (1) a separate contract for the additional goods or services in accordance with ASC 606-10- 25-12 (“View A”) or (2) the termination of an existing contract and the creation of a new contract in accordance with ASC 606-10-25-13(a) (“View B”). The issue was discussed with the AICPA’s revenue recognition working group but was ultimately elevated to a discussion with the FASB staff through the staff’s technical inquiry process.

During that process, the FASB staff indicated that both views are acceptable but noted that View B is more consistent with the staff’s interpretation of the contract modification guidance in the revenue standard. The staff also indicated that entities will still need to assess whether B&E transactions include significant financing components; however, the staff noted that it did not think that every B&E contract modification inherently involves a financing component.

Under View A, the supplier in the example above would treat the additional services (two years of electricity) as a separate contract. Therefore, the transaction price per unit during the remaining term of the existing contract would be unchanged at $50 per unit. When the existing contract term ends and the extension period begins, the supplier would recognize revenue of $40 per unit for the next two years. This approach would generate a contract asset in the two-year period remaining from the existing contract. That is because the supplier would receive less consideration ($45 per unit) than the amount of revenue recognized ($50 per unit).

Under View B, the supplier in the example above would treat the two-year extension period as a termination of an existing contract and the creation of a new contract. Therefore, the supplier would account for the modification prospectively by combining the transaction prices of the existing contract and the extension period for an average price of $45 per unit for the remaining four-year period. This approach would not generate a contract asset or liability since the amount received as consideration ($45 per unit) would be the same as the amount of revenue recognized.

The application of View A or View B focuses on whether the goods or services added during the extension period are priced at their stand-alone selling price. However, we believe that it is also acceptable for an entity to conclude that a B&E contract modification is always a termination of an existing contract and the creation of a new contract (i.e., an entity is not required to perform an analysis of the stand-alone selling price of the additional goods or services). The B&E contract modification is not just an increase in a contract’s scope (e.g., an extension of the arrangement) in exchange for an incremental fee because the pricing of the remaining goods or services in the original contract is also adjusted. That is, if the modification does not solely add goods or services for an incremental fee as described in ASC 606-10-25-12 (i.e., the modification also adjusts the pricing of the original goods or services), it would not be accounted for as a separate contract.

9.2.2.2.2 Blend-and-Extend Contract Modifications Related to a SaaS Arrangement

An entity that sells a SaaS solution may modify its arrangements before the end of the initial contract term by renewing the initial contract and revising the pricing on a “blended” basis for the remaining term, particularly if prices have decreased (i.e., a B&E contract modification). In such circumstances, the entity and its customer agree to extend the contract term and “blend” the remaining original, higher contract rate with the lower rate of the extension period for the remainder of the combined term. Consequently, when navigating the contract modification guidance, the entity may find it difficult to determine the appropriate accounting treatment. In a typical B&E contract modification in the SaaS industry, the entity would account for such a modification as either (1) a separate contract for the added services under ASC 606-10-25-12 or (2) a termination of the existing contract and the creation of a new contract under ASC 606-10-25-13(a).5 The determination of which model to apply may be based on whether the additional services are priced at their stand-alone selling prices (i.e., whether the conditions in ASC 606-10-25-12 are met).

We believe there are three alternatives for an entity to consider in determining how to account for a B&E contract modification.

In accordance with ASC 606-10-25-12(b), to determine whether a modification results in a separate contract, an entity must assess whether the price of the contract increases by an amount that reflects the stand-alone selling prices of the additional promised goods or services. We believe that if a modification is not just an increase in a contract’s scope (e.g., an extension of the SaaS arrangement) in exchange for an incremental fee because the pricing of the remaining goods or services in the original contract is also adjusted, it would be appropriate for the entity to account for the modification as a termination of an existing contract and the creation of a new contract. This is because the modification does not solely add goods or services for an incremental fee as described in ASC 606-10-25-12 (i.e., the modification also adjusts the pricing of the original goods or services). Under this view (hereafter referred to as “View A”), the entity does not need to perform an analysis of the stand-alone selling prices of the additional promised goods or services.

However, an entity may also apply one of the two views below to B&E contract modifications. Under these views, an entity must carefully analyze whether the additional goods or services are actually priced at their stand-alone selling prices to determine whether they should be accounted for as a separate contract:

View B — This view focuses on the net increase in the contract consideration (i.e., the total increase in consideration that the entity expects to be entitled to under the modified contract, including any changes to the prices of the remaining goods or services in the original contract), compared with the stand-alone selling prices of the additional promised goods or services. In determining how to account for the modification, the entity should compare the net increase in consideration with the stand-alone selling price of the services added during the extension period.
View C — This view focuses on the revised blended prices of the contract compared with the stand-alone selling prices of the additional promised goods or services. Therefore, the analysis focuses solely on whether the stated blended price is consistent with the stand-alone selling price of the additional services during the extension period.

An entity should consistently apply its elected method to similar contracts.

Example 9-4

On January 1, 20X8, Company S enters into a noncancelable contract with Customer T for a two-year term to provide a SaaS solution for a variable fee of $50 per usage. The stand-alone selling price of the SaaS ranges from $45 to $55 per usage. There are no other performance obligations in the contract. Company S determines that (1) it is providing a series of distinct services and (2) it is appropriate to recognize revenue by using a time-based measure of progress (i.e., ratably). In considering how much revenue to recognize in a distinct time period, S concludes that the contract meets the variable consideration allocation exception guidance in ASC 606-10-32-40, and therefore it recognizes revenue as usage occurs. In 20X8, T incurs usage-based fees for 1,000 transactions.

By January 1, 20X9, the stand-alone selling price range of the SaaS has decreased to $30 to $40 per usage. During negotiations, T renews the contract for an additional year but requests a decrease in pricing. As a result of negotiations, S and T agree to apply a blended rate of $43 per usage for the remaining two years of the modified contract. Customer T is expected to incur usage-based fees for 1,000 transactions per year for the remaining years.

The following three views could be applied:

View A — Company S accounts for the modification as a termination of the existing contract and the creation of a new contract. Therefore, it recognizes revenue at the blended transaction price of $43 per usage in both 20X9 and 20Y0.
View B — Company S computes the total increase in the contract consideration, which is $36,000 or $36 per usage, as follows:

Company S would then compare the increase in the transaction price to the stand-alone selling price range for the SaaS that will be provided during the extension period (i.e., 20Y0). Because $36 per usage is within the stand-alone selling price range of $30 to $40 per usage, S concludes that the extension period should be accounted for as a separate contract. Therefore, S will continue to recognize revenue in 20X9 at $50 per usage, but it will recognize revenue in 20Y0 at $36 per usage. In subsequent periods, S will need to (1) monitor actual usage and the remaining estimated usage and (2) accordingly update the transaction price and associated revenue recognized.
View C — Company S compares the revised blended rate of $43 per usage to the stand-alone selling price range for the SaaS that will be provided during the extension period. Because $43 per usage is outside the stand-alone selling price range of $30 to $40 per usage, S concludes that the modification should be accounted for as a termination of the existing contract and the creation of a new contract. The accounting outcome would be similar to that under View A.

9.2.2.3 Modification and Discount for Low-Quality Products

ASC 606-10

Example 5 — Modification of a Contract for Goods

[Case A omitted6]

Case B — Additional Products for a Price That Does Not Reflect the Standalone Selling Price

55-114 During the process of negotiating the purchase of an additional 30 products, the parties initially agree on a price of $80 per product. However, the customer discovers that the initial 60 products transferred to the customer contained minor defects that were unique to those delivered products. The entity promises a partial credit of $15 per product to compensate the customer for the poor quality of those products. The entity and the customer agree to incorporate the credit of $900 ($15 credit × 60 products) into the price that the entity charges for the additional 30 products. Consequently, the contract modification specifies that the price of the additional 30 products is $1,500 or $50 per product. That price comprises the agreed-upon price for the additional 30 products of $2,400, or $80 per product, less the credit of $900.

55-115 At the time of modification, the entity recognizes the $900 as a reduction of the transaction price and, therefore, as a reduction of revenue for the initial 60 products transferred. In accounting for the sale of the additional 30 products, the entity determines that the negotiated price of $80 per product does not reflect the standalone selling price of the additional products. Consequently, the contract modification does not meet the conditions in paragraph 606-10-25-12 to be accounted for as a separate contract. Because the remaining products to be delivered are distinct from those already transferred, the entity applies the guidance in paragraph 606-10-25-13(a) and accounts for the modification as a termination of the original contract and the creation of a new contract.

55-116 Consequently, the amount recognized as revenue for each of the remaining products is a blended price of $93.33 {[($100 × 60 products not yet transferred under the original contract) + ($80 × 30 products to be transferred under the contract modification)] ÷ 90 remaining products}.

Stakeholders have raised questions about Example 5, Case B, in ASC 606 (reproduced above). The example’s facts describe a contract modification in which an entity gives a customer a discount because goods and services previously delivered to the customer were determined to be of lower quality than that to which the parties had agreed. The example is designed to illustrate how an entity would apply the guidance in ASC 606-10-25-13(a), which describes a modification that would terminate the original contract and create a new one. In the absence of this example, a literal interpretation of the guidance in ASC 606-10-25-13(a) would require all of the consideration, inclusive of the discount negotiated in the modification for the 60 flawed products already delivered, to be recognized only when the undelivered products are delivered to the customer in the future (i.e., the modification is solely accounted for prospectively). That is, the allocation of the remaining consideration of $7,500 (which is the sum of (1) the original 60 remaining products × $100 per product and (2) the additional 30 products × $50 per product) would result in the recognition of $83.33 for each of the remaining 90 products delivered. This is because as of the date of the modification, the 90 products (60 in the original contract and 30 in the modification) are distinct from the 60 products already delivered.

Specifically, stakeholders have questioned how to determine the appropriate accounting approach when a contract is modified and the selling price reflects both (1) compensation for poor-quality goods or services that have already been supplied to the customer and (2) a selling price for the additional goods or services that does not represent the stand-alone selling price as of the date of the contract modification. Generally, we believe that entities should carefully consider the facts and circumstances in a modification and appropriately consider whether there is a price concession or discount attributable to past performance that is similar to the price concession in the example above.

For additional discussion related to differentiating changes in the transaction price from contract modifications, see Section 7.6.2.

9.2.2.4 Accounting for Contract Assets as Part of a Contract Modification

The revenue standard provides an overall framework for modification accounting. For example, when a contract modification meets the conditions in ASC 606-10-25-13(a), the modification is accounted for prospectively as a termination of the existing contract and the creation of a new one. The revenue standard also requires entities to record contract assets in certain circumstances, such as when an entity has a contract with a customer for which revenue has been recognized (i.e., goods or services have been transferred to the customer), but customer payment is contingent on a future event, such as the satisfaction of additional performance obligations (see Chapter 14). These contract assets may still be recorded at the time of a contract modification.

Stakeholders have expressed two views on how to subsequently account for contract assets that exist before a contract is modified when a contract modification meets the conditions in ASC 606-10-25-13(a):

View A — The terminated contract no longer exists. Accordingly, contract assets associated with the terminated contract should be written off to revenue (i.e., revenue should be reversed).
View B — Existing contract assets should be carried forward to the new contract and realized as receivables are recognized (i.e., revenue is not reversed, leading to prospective accounting for the effects of the contract assets).

View B is generally appropriate for three reasons. First, it better reflects the objective of ASC 606-10-25-13. Second, as noted in Q&A 81 of the FASB staff’s Revenue Recognition Implementation Q&As (the “Implementation Q&As”), “[p]aragraph 606-10-25-13(a)(1) explicitly states that the starting point for the determination [of the allocation in a modification] is the transaction price in the original contract less what had already been recognized as revenue.” Third, it is consistent with paragraph BC78 of ASU 2014-09, which notes that the intent of ASC 606-10-25-13(a) is to avoid adjusting revenue for performance obligations that have been satisfied (i.e., such modifications would be accounted for prospectively).

The above issue is addressed in Implementation Q&A 81 (compiled from previously issued TRG Agenda Papers 51 and 55). For additional information and Deloitte’s summary of issues discussed in the Implementation Q&As, see Appendix C.

The example below illustrates the accounting for a contract asset as part of a contract modification.

Example 9-5

Entity M enters into a contract with Customer R to sell a product and one year of service. The product and service are separate performance obligations. The one year of service is considered to be a series of distinct services that meet the criteria in ASC 606-10-25-14(b) to be accounted for as a single performance obligation satisfied over time. Entity M’s performance obligation related to the product is satisfied at the point in time that the product is shipped to R, which occurs at the beginning of the first month.

The transaction price of the contract is $7,500, which is paid by R in 12 equal installments of $625 at the end of each month. Under these payment terms, the customer does not make an up-front payment when the product is shipped. The stand-alone selling price of the product is $2,700, and the stand-alone selling price of the services is $4,800 ($400 per month). Because the sum of the stand-alone selling prices equals the transaction price, the amount allocated to each performance obligation is the stand-alone selling price of that performance obligation.

At the end of six months, the contract is modified to include one additional year of service beyond the initial one-year service term. Customer R is current with all payments, and the modification does not affect the amounts due for the remaining six months of service under the initial one-year service term (i.e., R continues to pay $625 each month for the remaining six months of the initial one-year service term). The price for the additional one year of services is $100 per month, which does not represent the stand-alone selling price of the services. Because the remaining services to be provided are distinct from the product and services already delivered to R, the modification is accounted for prospectively under ASC 606-10-25-13(a).

The journal entries below illustrate how M should recognize revenue at contract inception and in the months leading up to the contract modification. For simplicity, the journal entries ignore any effect of a significant financing component.

At contract inception, to recognize revenue for the product shipped to R:

At the end of each of months 1 through 6, to recognize revenue for the monthly services:

After six months, immediately before the modification, M has recognized revenue of $5,100 ($2,700 for the product and $2,400 for the services) and has a cumulative contract asset balance of $1,350.

Entity M would retain the original contract asset of $1,350 on the modification date. The remaining consideration to be allocated consists of two components:

$2,400 for the transaction price not yet recognized as revenue under the initial contract ($625 per month × 6 months remaining, less $1,350 contract asset balance).
$1,200 for the additional one year of services ($100 per month × 12 months).

The total transaction price for the modified contract of $3,600 ($2,400 + $1,200) is allocated to the remaining months of service under the modified contract term; as a result, M recognizes revenue of $200 per month for the remaining 18-month contract term. The contract asset that existed on the modification date will be reduced as amounts received or receivable exceed revenue recognized; once the contract asset is recovered, amounts received or receivable in excess of revenue recognized will be reflected as a contract liability. This is reflected in the journal entries below.

At the end of each of months 7 through 9:

At the end of month 10:

Before revenue is recognized at the end of month 10, the cumulative contract asset balance is only $75, or $1,350 – ($425 × 3). When a contract asset is fully recovered (i.e., is reduced to zero), consideration received in excess of revenue recognized is reflected as a contract liability. Consequently, a contract liability is recorded for the remaining amounts that are received or receivable in excess of revenue recognized.

For each of months 11 and 12, the contract liability will be recorded in the manner shown in the journal entry below.

At the end of each of months 11 and 12:

As of the end of month 12, the cumulative contract liability balance is $1,200; and beginning with month 13, amounts due under the modified contract are reduced to $100 per month. Revenue recognized for each month of service continues to be $200. This is reflected in the journal entry below for each of months 13 through 24.

At the end of each of months 13 through 24:

The results of this model are summarized in the table below.

9.2.2.5 Accounting for Capitalized Costs of Obtaining a Contract When a Contract Is Modified

ASC 340-40-25-1 requires entities to capitalize incremental costs incurred to obtain a contract with a customer when such costs are expected to be recovered. ASC 340-40-35-1 requires entities to amortize such capitalized costs “on a systematic basis that is consistent with the transfer to the customer of the goods or services to which the asset relates.” The asset may be related to goods or services to be transferred under specific anticipated contracts. See Section 13.4.1.3 for a discussion of how to account for capitalized costs incurred to obtain a contract that are still recorded at the time of a contract modification.

9.2.2.6 Customer’s Exercise of a Material Right

As noted in Section 11.7, the TRG discussed questions raised by stakeholders about the accounting for a customer’s exercise of a material right. Specifically, stakeholders questioned whether an entity should account for a customer’s exercise of a material right in one of the following ways:

Alternative A — As a change in the contract’s transaction price such that the additional consideration, along with the consideration from the original contract that was allocated to the material right, would be allocated to the performance obligation underlying the material right and would be recognized when or as the performance obligation underlying the material right is satisfied.
Alternative B — As a contract modification, which may require reallocation of consideration between existing and future performance obligations.

Although most TRG members thought that both Alternatives A and B could be supported by the revenue standard, most TRG members leaned toward Alternative A. Accordingly, we believe that while the guidance in ASC 606 supports the two alternatives outlined above, it is generally preferable to account for a customer’s subsequent exercise of a material right as if it were a separate contract (Alternative A) rather than as if it were the modification of an existing contract (Alternative B). See Section 11.7 for further discussion.

Connecting the Dots

A customer’s exercise of an option to purchase additional goods or services that was accounted for as a “marketing offer” is different from a customer’s exercise of a material right contained within the original contract. We generally would not consider it appropriate for an entity to analogize to the alternatives outlined above on the basis of the TRG discussion when accounting for a marketing offer. Example 50 in ASC 606 (reproduced in Section 11.2) illustrates a contract with an option for additional services that is akin to a marketing offer rather than a material right because the prices of the additional services under the option represent the stand-alone selling prices of those services. Because a marketing offer in an original contract is not accounted for as a material right and therefore is not treated as part of the original contract, the exercise of the marketing offer at a subsequent date should be accounted for as a new contract (i.e., the exercise of the marketing offer is a separate contract because the additional goods or services are distinct and priced at their stand-alone selling prices).

9.2.2.7 Contract Modifications That Reduce the Scope of a Contract

The revenue standard specifically states that a contract modification is a change in the scope or price of a contract. Therefore, a contract modification can be one that adds or removes promised goods or services or changes the contract price. There can be situations in which part of a contract is terminated and the change would be a contract modification.

Depending on whether the remaining goods or services in the existing contract are distinct from those transferred before the modification, ASC 606-10-25-13 requires an entity to account for a contract modification that results in a decrease in scope (i.e., the removal from the contract of promised goods or services) as either (1) the termination of the existing contract and the creation of a new contract or (2) a cumulative catch-up adjustment to the existing contract. The modification cannot be accounted for as a separate contract because the criterion in ASC 606-10-25-12(a) specifying an increase in the scope of the contract is not met (i.e., by its very nature, a new contract that decreases the quantity of goods or services promised in the original contract is inherently modifying the original contract and is not separate).

Example 9-6

Application of ASC 606-10-25-13(a) to a Modification Resulting in a Reduction in the Scope of a Contract That Provides for a Series of Distinct Goods or Services Accounted for Under ASC 606-10-25-14(b)

Entity Y enters into a contract with a customer to provide Product X and 12 months of services to be used in conjunction with Product X in return for consideration of $140; the services portion of the contract qualifies as a series in accordance with ASC 606-10-25-14(b). Product X and the services are each determined to be distinct, with consideration of $40 allocated to Product X (recognized on transfer of control of Product X) and consideration of $100 allocated to the services portion of the contract (recognized over the 12-month service period).

Six months after the start of the contract, the customer modifies the contract to reduce the level of service required. By the time of this modification, Y has already (1) recognized revenue of $40 for delivery of Product X, (2) recognized revenue of $50 for services provided to date, and (3) received payment from the customer of $110, creating a contract liability of $20. Entity Y agrees to a reduction in price such that the customer will pay only $10 in addition to the payments already made.

Given that the remaining six months of service are distinct from both the delivery of Product X and those services provided in the first six months of the contract, this decrease in scope (and price) should be accounted for as a termination of the existing contract and the creation of a new contract as required by ASC 606-10-25-13(a), with $30 allocated to the services still to be provided (i.e., the $20 previously collected from the customer but not recognized as revenue plus the remaining $10 due under the modified contract).

Entity Y could alternatively calculate the $30 allocated to the services still to be provided by considering the $50 of the original transaction price yet to be recognized ($140 transaction price, less the $40 recognized as revenue for delivery of Product X and the $50 recognized as revenue for services provided to date), less the $20 reduction of the total transaction price since the customer agrees to pay only an additional $10. As a result, Y would allocate $30 ($50 in remaining revenue to be recognized under the original contract less the $20 reduction of the transaction price) to the services still to be provided.

Example 9-7

Application of ASC 606-10-25-13(b) to a Modification Resulting in a Reduction in the Scope of a Contract That Contains a Single Combined Performance Obligation Accounted for Under ASC 606-10-25-14(a)

Entity X enters into a contract to produce a single large item of specialized machinery for a customer. Multiple components are used in the production of the specialized machinery, but they are significantly integrated so that X is using the goods as inputs to produce the combined output of the specialized machinery. Therefore, X concludes that the contract contains a single combined performance obligation in accordance with ASC 606-10-25-14(a). In addition, X concludes that the performance obligation should be recognized over time in accordance with ASC 606-10-25-27. Four months into the contract term, the customer decides to purchase a component of the project from an alternative source; X agrees to this contract modification, which reduces the contract scope.

Since the remaining goods or services to be provided are not distinct from those already provided, ASC 606-10-25-13(b) requires X to (1) account for the contract modification as part of the existing contract and (2) recognize a cumulative catch-up adjustment to revenue at the time the modification occurs.

Refer to Example 8 in ASC 606-10-55-129 through 55-133 for an example of the calculation of a cumulative catch-up adjustment under ASC 606-10-25-13(b).

Example 9-8

Application of ASC 606-10-25-13(a) to a Partial Termination of a Contract That Provides for a Series of Distinct Goods or Services Accounted for Under ASC 606-10-25-14(b)

Provider P has entered into an enforceable contract to deliver 25 hours of routine and recurring cleaning services every month to Customer C for five years at a fixed price of $1,000 per month (total transaction price of $60,000), which represents the stand-alone selling price for cleaning services at contract inception.

At the end of year 1 (i.e., year 1 has passed and both parties have met all of their performance and payment obligations during that period), the market for cleaning services has declined and the customer’s need for cleaning services has changed. Customer C and P agree to reduce the remaining term of the contract to two years (i.e., terminate years 4 and 5 of the contract) but do not change the fixed price of $1,000 per month. The stand-alone selling price of the cleaning services is $750 per month on the date of the contract modification.

To compensate P for its lost value on years 4 and 5 of the contract when C would have to pay P at above-market rates, C agrees to pay a $6,000 penalty (i.e., 24 months in years 4 and 5 × $250 per month, the excess of the contract rate of $1,000 over the stand-alone selling price of $750 on the date of modification).

Provider P accounts for the contract as a series of distinct services with the same pattern of transfer to C in accordance with ASC 606-10-25-15 and, therefore, as a single performance obligation satisfied over time in accordance with ASC 606-10-25-27(a) (and ASC 606-10-55-5 and 55-6). Provider P uses an output method based on time elapsed to measure its progress toward complete satisfaction of its performance obligation.

Provider P should account for the partial termination as a contract modification in accordance with ASC 606-10-25-10 through 25-13. The criteria for accounting for a contract modification as a separate contract in ASC 606-10-25-12 are not met because the scope of the contract does not increase. Consequently, P should account for the modification in accordance with the guidance in ASC 606-10-25-13(a), the application of which would result in accounting for the modification as a termination of the old agreement and the creation of a new agreement.

Provider P should therefore account for the modification prospectively and recognize $30,000 (i.e., $12,000 per year under the original terms for years 2 and 3 plus the $6,000 compensation payment) over the remaining revised contract period of two years.

Footnotes

For illustrative examples, see Example 9-3; ASC 606-10, Examples 8 and 9; and Example 9-7.

For illustrative examples, see Example 9-2; ASC 606-10, Example 5, Case B; ASC 606-10, Example 7; Example 9-6; Example 9-8; and ASC 606-10, Example 6

For an illustrative example, see ASC 606-10, Example 5, Case A.

Cumulative adjustments to revenue under ASC 606-10-25-13(b) are not common for these types of modifications of SaaS arrangements because the services provided after the modification are typically distinct from those transferred before the modification. Therefore, this discussion does not focus on modifications that would result in an adjustment to revenue.

Case A of Example 5 is reproduced in Section 9.2.1.

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