Stakeholders have raised questions about whether the exercise of a material right should be accounted for as a contract modification or as continuation of the current contract. Consider the following example:

The staff thinks that the guidance in the standard could be read to support the following two views as reasonable interpretations of the guidance:

Only in cases in which the optional goods or services are determined to be not distinct from the original promised goods or services, would the accounting results appear to differ. The staff thinks that an entity typically would conclude that an optional good or service is distinct. The method used to account for the exercise of a material right will depend on the facts and circumstances of the arrangement. The staff thinks that the method used should be applied consistently by an entity to similar types of material rights with similar facts and circumstances.

The following is the application of the two views to the example above.

Entity accounts for Customer’s exercise of its option to purchase Service B as a continuation of the contract. The transaction price is updated to reflect the consideration received in exchange for Service B. The amount allocated to Service A, less any amounts previously recognized as revenue (for example, Entity would have recognized revenue of $18.75 for Service A when the option was exercised six months into the two-year contractual term), is recognized as revenue over the remainder of the two-year period over which Service A is transferred. The $300 of consideration related to service B is added to the amount previously allocated to the option to purchase Service B (that is, a total of $325) and is recognized as revenue over the two-year period over which Service B is transferred. In this example, none of the transaction price allocated to the material right had been recognized as revenue at the date the option was exercised by Customer.

According to this view, the exercise of a customer option is not a contract modification because it is not a change in the scope or price of a contract. Rather, the exercise of a customer option is an exercise of an existing provision in the contract. Any additional consideration received, or additional goods or services provided upon the exercise of a customer option were contemplated as part of the original contract, as evidenced by a portion of the transaction price being allocated to the customer option as a separate performance obligation.

Alternatively, the entity may account for Customer’s exercise of its option to purchase Service B as a contract modification. Entity evaluates the contract modification guidance in paragraph 606-10-25-12 and determines that the contract modification should not be accounted for as a separate contract because the price of the contract did not increase by an amount of consideration that reflects Entity’s standalone selling price of Service B.

Entity must then evaluate the guidance in paragraph 606-10-25-13 to determine how it should account for the modification. Depending on its evaluation of the guidance in paragraph 606-10-25-13, Entity may be required to recognize a cumulative catch-up adjustment to revenue on the date of the modification. A cumulative catch-up adjustment would not be recognized under View A or, under paragraph 606-10-25-13(a) if the entity concludes that the remaining goods or services to be provided after the modification are distinct from those transferred to the customer before the modification. However, a cumulative catchup adjustment would be required if Entity accounts for the modification in accordance with paragraphs 606-10-25-13(b) or (c).

According to this view, any additional consideration or additional goods or services provided upon the exercise of a customer option represent a change in the price and scope of a contract and should be accounted for as a modification of the contract. The original goods or services are those promised in the contract, including any material right(s). The option, when exercised, is viewed as a change in the scope of the contract because the good or service was not contracted for in the original contract. Per this view, the exercise of an option that did not provide the customer with a material right could in some cases be considered a contract modification (for example, adding a new service to an existing services contract) and do not think that conclusion should differ just because the option does, or does not, provide the customer with a material right.

The staff observes that the nature of material rights can vary significantly from one entity to next. The staff thinks an entity will need to apply judgment to determine a practical approach to accounting for material rights, including deferring revenue when the right is granted and recognizing revenue as the future goods or services are transferred to the customer. An entity might also consider the practical expedient in paragraph 606-10-10-4 that permits an entity to apply the standard to a portfolio of similar contracts, rather than on an individual contract basis.