Step 1 of the revenue standard requires an entity to identify the contract with the customer. Guidance in paragraph 606-10-25-1 provides five criteria to consider. Paragraph 606-10-25-2 provides additional guidance on identifying the contract. Because the guidance refers to enforceability of rights and obligations and refers to those notions as a matter of law, private company stakeholders have raised questions about whether legal consultation is a requirement in all cases. The staff observes that this question is in part arising because of some interpretations published by third parties on this topic. The staff would like to clarify that there is no requirement in Topic 606 that states that companies are required to consult with legal counsel for all revenue transactions.

Because it is not a GAAP requirement to consult with legal counsel, questions arise about specifically when private companies may want to consider consultation. The staff observes that, in some cases, it might not be clear whether a contract exists and, thus, additional work would be required (which may or may not require legal assistance, depending on the facts and circumstances); however, the staff thinks that this would be a minority population of contracts and not dissimilar from today’s requirements.

Although the guidance notes that enforceability is a “matter of law,” it is the staff’s view that, in most cases, it will be obvious if the contract meets Step 1 of the five-step model. Also, the staff notes that the guidance only requires that a contract with a customer be identified and does not require a contract to be written. That is, oral arrangements may also meet the definition of a contract (oral contracts are explicitly mentioned in paragraph 606-10-25-2). The staff notes that in cases in which a written contract does not exist, a company may need to perform additional due diligence to assert that Step 1 has been met considering the company’s customary business practices. However, the staff does not think that this is a change from current practice. In the absence of a written contract today, companies have a higher hurdle to demonstrate that the revenue is realizable as compared with those arrangements with a written contract.

Some stakeholders have had concerns that the guidance would require companies to wait for cash collection to recognize revenue when the definition of a contract is not met at inception. The staff thinks it’s important to keep in mind that if an entity determines it does not meet the definition of a contract at inception, the guidance requires that the entity continue to reassess the contract to determine if the definition is subsequently met (606-10-25-6). Therefore, failure of Step 1, identifying the contract, at inception does not necessarily mean that revenue would be deferred until receipt of payment because it could meet Step 1 at a date after inception but before payment.