This question relates to when, if ever, the goods or services underlying the option to purchase additional goods or services should be a performance obligation when there are no contractual penalties that compensate the other party. There are various reasons why an entity might think it is virtually certain (or highly probable/probable) that the customer will exercise its option for additional goods or services. This might be the case, for example, in cases in which the entity is the sole provider of the goods or services and/or the contract includes an exclusivity clause that requires the customer to acquire those goods and services only from the entity.

The staff view is that goods or services must be legally enforceable in order to be considered a performance obligation. Items that as a “matter of law” (paragraph 606-10-25-2) are optional from the customer’s perspective should not be identified as goods or services promised in the contract and, therefore, not identified as performance obligations. The options should instead be assessed to determine whether the customer has a material right. As a result, consideration that would be received for optional goods or services if the customer exercises its right should not be included when determining the transaction price for the existing contract.

This is because the option for the customer to purchase additional goods or services represents a right that should be evaluated in accordance with paragraphs 606-10-55-41 through 55-45 to determine whether it represents a material right (and if so, a portion of the consideration would be allocated to the right). Paragraph 606-10-55-42 states that an option to acquire additional goods or services “gives rise to a performance obligation in the contract only if the option provides a material right to the customer.” This view is consistent with paragraph BC186 of Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606), that the transaction price should only include amounts to which the entity has rights under the present contract and should “not include estimates of consideration from the future exercise of options for additional goods or services.”

Consider the following examples:

Scenario A: The entity sells the equipment for CU6,000 (40% discount from standalone selling price) with a contractual option to purchase each part for CU100. There are no contractual minimums; however, the entity estimates the customer will purchase 200 parts over the 2 years. Assume, that the seller and customer have an exclusive contract where the customer cannot purchase the goods from other vendors during the contract term.

The parts underlying each option would not be considered a part of the contract and there is no material right. The transaction price is CU6,000, which is entirely attributable to the equipment, and the entity would have a loss of CU2,000 when it transfers control of the equipment to the customer.

Scenario B: The entity sells the equipment for CU10,000 and each part for CU80 (the entity concludes the 20% discount on parts is material). The customer is not required to purchase any parts; however, the option to purchase parts represents a material right. Assume the entity estimates 200 parts would be purchased and the standalone selling price of the material right is CU4,000.

The discount on the option to purchase each part would give rise to a material right and the contract would have two performance obligations, the equipment and the material right. The transaction price (CU10,000) would be allocated to the performance obligations based on the standalone selling price (4,000 [200 estimated purchases * 20 discount] for the material right and 10,000 for the equipment) of each performance obligation (CU7,143 [10,000/14,000 * 10,000] allocated to the equipment and CU2,857 [4,000/14,000 * 10,000] to the material right). The allocated transaction price would be recognized as each performance obligation is satisfied. The entity would recognize a loss on the sale of the equipment and some of the transaction price is deferred until parts are transferred.

The contract is a month to month contract because the termination clause is akin to a renewal right. Because the prices charged for each month are at the standalone selling price there is no material right. The upfront payment made to the customer by the vendor does not affect the analysis of the material right because the failure to renew does not affect the customer’s ability to retain the payment from the vendor and, therefore, would not be considered a penalty. As such, only the future options are considered and paragraph 606-10-55-43 clarifies that even if the contract provides a right to exercise an option because of a present contract, that option is considered a marketing offer if there is not a material right.

In summary, the staff does not think Topic 606 requires estimating future contracts the customer will enter into with the vendor. The staff thinks that options are only a performance obligation if the option provides the customer with a material right (that is, the underlying goods or services are not the performance obligation). Furthermore, the staff thinks paragraph 606-10-55-43 clarifies that even if the contract provides a right to exercise an option because of a present contract, that option is considered a marketing offer if it does not represent a material right. Finally, if the upfront deliverable in the arrangement is considered a distinct good or service, the staff thinks it is counterintuitive to conclude that the entity is economically compelled to purchase additional items solely because they are utilized with the upfront good. That is because if the good or service is distinct, then the customer can benefit from that good or service on its own without any additional goods or services and the promise is separately identifiable from the other promises in the contract.

The staff also does not view optional purchases of additional goods or services to be similar to implied promises in a contract. The staff thinks the guidance in paragraph 606-10-25-16 is specific to promises made by the vendor that creates an expectation of the customer. In other words, the consideration in the current contract relates to those promises implied by the vendor rather than pulling forward consideration from future contracts.

The staff notes that there is often judgment required to determine the extent of the contract and entities also should consider the guidance in paragraph 606-10-25-9 on contract combination. The staff’s view on options to purchase additional goods or services does not preclude an entity from making judgments about the extent of the legal contracts (which is a determination that requires consideration of the terms and conditions of the contract together with the legal framework in the relevant jurisdiction) and when those contracts should be combined with other contracts.