Technology Highlights — Challenges Associated With Applying the New Revenue Standard: Blend-and-Extend Modifications Related to a Cloud-Based or Hosted Software Arrangement
For public entities, the new revenue standard (ASC 6061) became effective for annual reporting periods beginning after December 15, 2017.
The standard is effective for all other entities for annual reporting periods beginning
after December 15, 2018. Early adoption is permitted for annual reporting periods
beginning after December 15, 2016.
While ASC 606 will affect organizations differently depending on their
facts and circumstances, we have identified certain aspects of its application that are
especially challenging for technology companies. This Technology Alert is part of
a series intended to help technology entities better understand the
new guidance, particularly private organizations that are currently adopting the
standard’s requirements.
Executive Summary
ASC 606-10-25-10 specifies that a contract modification is “a change in the scope
or price (or both) of a contract.” Under ASC 606-10-25-12, such a modification
must be accounted for as a separate contract when (1) the “scope of the contract
increases because of the addition of promised goods or services that are
distinct” and (2) 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” as adjusted to reflect the circumstances
of the contract (e.g., a discount that the entity provides because it did not
incur additional selling-related costs when modifying the contract). If the
contract modification does not result in a separate contract, the entity must
determine whether the modification constitutes (1) a termination of the existing
contract and the creation of a new contract because the remaining goods or
services are distinct, (2) a part of the existing contract because the remaining
goods or services are not distinct, or (3) a combination of (1) and (2).
An entity that sells a cloud-based or hosted software solution (e.g., a
software-as-a-service (SaaS) arrangement)2 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
“blend-and-extend 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 blend-and-extend 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).3 The determination of which model to apply is based on whether the
additional services are priced at their stand-alone selling prices (SSPs) (i.e.,
whether the conditions in ASC 606-10-25-12 are met).
The interpretive guidance below discusses three alternatives for an entity to
consider in determining how to account for a blend-and-extend modification.
Interpretive Guidance
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 SSPs 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 SSPs of the additional
promised goods or services.
However, an entity may also apply the two views below to blend-and-extend
modifications. Under these views, an entity must carefully analyze whether the
additional goods or services are actually priced at their SSPs to determine
whether they should be accounted for as a separate contract:
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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 SSPs 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 SSP of the services added during the extension period.
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View C — This view focuses on the revised blended prices of the contract compared with the SSPs of the additional promised goods or services. Therefore, the analysis focuses solely on whether the stated blended price is consistent with the SSP of the additional services during the extension period.
An entity should consistently apply its elected method to similar contracts.
Example
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
SSP 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 SSP 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.
Question
How should S account for the modification?
Answer
The following three views could be applied:
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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.
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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 SSP range for the SaaS that will be provided during the extension period (i.e., 20Y0). Because $36 per usage is within the SSP 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.
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View C — Company S compares the revised blended rate of $43 per usage to the SSP range for the SaaS that will be provided during the extension period. Because $43 per usage is outside the SSP 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 in View A.
Contacts
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Sandie Kim
Audit & Assurance Partner
National Office Accounting and
Reporting Services
Deloitte & Touche LLP
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Tyler Murakami
Audit & Assurance Manager
National Office Accounting and
Reporting Services
Deloitte & Touche LLP
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Michael Wraith
Audit & Assurance Partner
U.S. Technology Industry
Professional Practice Director
Deloitte & Touche LLP
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Mohana Dissanayake
Audit &
Assurance Partner
U.S. Technology,
Media & Telecommunications Industry Leader
Deloitte &
Touche LLP
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Previn Waas
Audit & Assurance Partner
U.S. Software Industry Leader
Deloitte & Touche LLP
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Footnotes
1
For titles of FASB Accounting Standards Codification (ASC) references, see
Deloitte’s ”Titles of Topics and Subtopics in
the FASB Accounting Standards Codification.”
2
In this publication, it is assumed that the SaaS arrangement is accounted
for as a service contract because the customer does not have the ability
to take possession of the underlying software license on an on-premise
basis.
3
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 publication
does not focus on modifications that would result in an adjustment to
revenue.