Determining the nature of the good or service an entity is promising to transfer to the customer is fundamental to properly accounting for a performance obligation. Paragraph 606-10-25-33 states that doing so is necessary in order to determine the appropriate measure of progress for a performance obligation. However, some stakeholders are raising questions about determining the nature of the good or service that is being provided to the customer in arrangements. Those stakeholders question whether the nature of the good or service underlying promises such as Types A through D is the act of “standing ready” or whether it is the actual delivery of the underlying goods or services that the entity stands ready to provide to the customer.

The staff thinks that whether the obligation is to provide a defined good or service (or goods or services), or instead, to provide an unknown type or quantity of goods or services might be a strong indicator as to the nature of the entity’s promise in the contract. The staff notes, however, that in either case the entity might be required to “stand ready” to deliver the good(s) or service(s) whenever the customer calls for them or upon the occurrence of a contingent event (for example, snowfall).

In general, in a contract to provide, for example, 100 specified goods or services, the nature of the entity’s promise is to provide those goods or services, and that this would be the case regardless of whether the customer was able to specify the timing for the transfer of those goods or services.

In contrast, in arrangements such as Type B, C, or D (that is, where the entity will provide uncertain goods or services—for example, the entity knows it will provide maintenance services, but does not know how many service calls it will make or what it will be required to fix), the entity provides a service to the customer in “standing ready” to perform. Paragraph BC160 of Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606), supports the view that the Board intended that, in some cases, the nature of the “entity’s promise is to stand ready for a period of time, rather than providing a service only when the customer requires it.” The customer obtains (that is, receives and consumes) a benefit from the assurance that a “scarce” resource is available to it (“standing ready”), when-and-if needed or desired. Some additional examples that might further illustrate the benefit a customer obtains from the entity “standing ready” include:

Some stakeholders have suggested that promises of the nature described as Type A above (for example, to provide when-and-if available updates or upgrades in software or biotechnology licensing arrangements) require additional analysis to determine the nature of the promise because the entity, rather than the customer or external events, might unilaterally control when updates or upgrades become available for transfer to the customer. However, given that an entity often will not be able to predetermine when a major intellectual property improvement will be completed and available for transfer to a customer, how many will be completed and available for transfer during the contract period, or what features or functionality will be included as part of those upgrades, the nature of the entity’s promise in “Type A” arrangements might have considerable similarity to those described as Types B through D above. For example, a biotechnology company likely cannot unilaterally determine when its scientists will make a research and development advancement for a drug or compound. As another example, a software company might have no major update or upgrade available for release during a contract period, particularly if the contract period is relatively short (for example, a one-year software post-contract customer support—or PCS—renewal period). In those examples, the entity’s performance with respect to a Type A, when-and-if available upgrade right might, similar to those other types of obligations, be dependent upon events or circumstances that are largely outside the entity’s control.

Similar to obligation Types B through D, a Type A promise to when-and-if available (that is, unspecified) upgrades is also often about the customer obtaining assurance that it will have access to future improvements to the product it has obtained or the intellectual property it has licensed. Using a software license as an example, if the promise is truly to unspecified upgrades (that is, the upgrades are not merely implicitly specified and promised to the customer in accordance with paragraph 606-10-25-16—see next paragraph), then the nature of (and benefit from) that promise is the entity providing the customer with a guarantee against obsolescence or defects in the software. This guarantee provides benefit to the customer by protecting the customer’s investment in the software (which may include, for example, an expensive implementation that would not be recovered economically if the customer had to implement a new software solution in the nearer medium-term) and/or the customer’s related business interests (for example, a customer that embeds the entity’s software in its own products might want assurance that it will have access to upgrades of the software so that its products remain competitive in the marketplace). Absent the unspecified upgrade right, the entity might charge the customer exorbitant fees in a separate negotiation for the next version of the software or might enter into an exclusive arrangement with another customer that restricts the customer’s ability to obtain the upgrades.

In determining the nature of its promise to a customer in a Type A arrangement, an entity should carefully consider whether it has promised one or more specified upgrades to a customer even if the contract refers only to unspecified upgrades that will be transferred to the customer only when-and-if they become available. Paragraph 606-10-25-16, as well as the discussion in paragraph BC87 of Update 2014-09, clearly stipulate that if the customer has a valid expectation (for example, that a specific upgrade will be transferred to the customer), then the customer would view those promises as part of the negotiated exchange. In that case, the entity’s promises to the customer might include both an unspecified upgrade right (that is, the right to any updates or upgrades that may become available, but are not explicitly or implicitly promised to the customer) and a specified upgrade right (for example, a specific version upgrade, with specifically anticipated additional or changed functionality, or an enhancement that has been implicitly promised to the customer by the entity’s customary business practices, specific statements, or other communications), or might just include a specified upgrade right. A promise to deliver a specified upgrade should be accounted for in the same manner as any other specifically promised good or service (for example, a promise to deliver a specified intellectual property upgrade should be evaluated in the same manner as any other license of intellectual property).