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Question 12: Should the evaluation of whether an option provides a material right be performed in the context of only the current transaction with a customer or should the evaluation also consider past and expected future transactions with the customer?
Publication date: 31 Jan 2020
us FASB Staff Q&A Revenue 12
Reference(s): Section 606-10-25 and Paragraph 606-10-55-42
Because paragraph 606-10-10-4 (among others) indicates that Topic 606 applies to individual contracts with a customer, some have questioned the accounting for certain types of transactions that provide customers with rights in a current transaction that may only become material when combined with rights that have been accumulated in past transactions and/or will be accumulated in future transactions.
The staff thinks that the evaluation of whether an option provides a material right should consider all relevant transactions with the customer (that is, current, past, and future transactions).
All facts and circumstances, including those that exist outside of the current transaction with a customer, should be considered when evaluating whether a customer option gives rise to a material right. That is, forward-looking factors, such as how a right accumulates over time, should be considered when evaluating whether an existing option gives rise to a material right. Paragraph 606-10-55-42 indicates that when evaluating a discount in a contract, consideration should be given to “discounts typically given for those goods or services to that class of customer in that geographical area or market,” which they state further supports considering facts and circumstances beyond the current transaction with the customer.
To illustrate, consider the examples below. The estimated standalone selling prices used in all examples in this Q&A have been created for illustrative purposes only and are not meant to demonstrate actual standalone selling prices. However, it should be assumed that the standalone selling prices were calculated consistent with the methodologies in Topic 606.
Example 1—Loyalty Program
Entity A has a loyalty program in which its customers accumulate one point for every dollar spent. Points may be exchanged for free products when the customer accumulates enough points. Based on its historical data, Entity A determines that it is likely that its customers will accumulate enough loyalty points to receive a free product. In the current transaction, Customer Y purchases a product from Entity A for $50 and receives 50 loyalty points. Entity A concludes that each loyalty point has a standalone selling price of $0.01.
Entity A would consider whether the loyalty points earned from the current transaction are expected to contribute to a material right that the customer has (or will accumulate). The evaluation would consider that an element of the right granted to Customer Y in the current transaction is the customer’s ability to accumulate loyalty points that will entitle the customer to a free product.
Example 2 —“ Buy three and get one free” program
Entity A offers a program in which customers who have purchased three products over a given period of time may receive a fourth product free. Based on its historical data, Entity A determines that it is likely that its customers will receive a free product.
After a customer purchases the first of the three products, the customer has obtained an option (that is, an escalating right) that allows the customer to receive a free product if the customer chooses to purchase two additional products. Similarly, after the customer purchases the second of the three products, it receives an option that allows the customer to receive a free product if the customer chooses to purchase one additional product. After completion of the third product purchase, the customer has an option to obtain a free product. As a result, the standalone selling price of each option may be different.
Assume that in the current transaction, which is the customer’s first of the three required purchases, Customer Y purchases a product from Entity A at its observable standalone selling price of $6. Entity A concludes that the standalone selling price of the customer option in this transaction is $0.30.
Entity A would consider that Customer Y has in-substance earned one-third of a free product in the current transaction (or in other words, has earned the right to receive one free product if the customer purchases two additional products). Entity A also would consider whether Customer Y is likely to purchase two additional products that will entitle it to a free product.
Copyright #year# by Financial Accounting Foundation, Norwalk, Connecticut.
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