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Question 43: How should an entity account for upfront payments to a customer?
Publication date: 30 Jan 2020
us FASB Staff Q&A Revenue 43
Reference(s): Section 606-10-32
Payments to customers are common in many industries. Payments to customers (or potential customers) can take the form of cash or other items (for example, a coupon, a credit, or a voucher). Scenarios also include the issuance of equity. For example, an entity may make a payment to a customer to:
(a) Reimburse the customer for costs associated with entering into a contract (such as costs for setting up a new vendor or costs to shut down operations that will be outsourced to the vendor)
(b) Obtain a customer contract in a competitive environment (pay-to-play or exclusivity)
(c) Provide additional incentives or discounts to customers.
The scope of the issue discussed in this Q&A is about payments to customers (and, arguably, potential customers). The analysis in this Q&A does not apply to payments that are made to third parties that are not customers (or potential customers). This is because Topic 606 applies to contracts with customers and does not provide guidance on payments to other parties (for example, a payment an entity makes to its vendor for services received), as described in paragraph 606-10-32-26.
Although this Q&A applies to payments to customers, sometimes the very challenge with this topic is determining whether the payment is to a customer. An entity will need to apply judgment in some circumstances to determine whether the counterparty to the arrangement is a customer in a revenue contract(s). The following are some examples for which judgment may be needed:
(a) An entity might make a payment to a third party that has never been a customer of the entity, but the payment is made as part of contract negotiations to incentivize the third party to become a customer. The third party is not required to make purchases to receive the payment (for example, purchases are at the option of the third party).
(b) An entity might have conducted business in prior transactions with the counterparty as a customer, but because of the nature of the current arrangement, there is some ambiguity about whether the counterparty is a customer in the current arrangement. For example, a counterparty might be a longstanding customer in a particular segment, but that same counterparty is a collaborator in another segment (for example, development of a new product).
(c) An entity might determine that the counterparty is a collaborator, rather than a customer, if the counterparty has not contracted with an entity to obtain goods or services that are an output of the entity’s ordinary activities. (The FASB received an agenda request from a stakeholder about accounting for collaborative arrangements under Topic 808. See Accounting Standards Update No. 2018-18, Collaborative Arrangements (Topic 808): Clarifying the Interaction between Topic 808 and Topic 606).
(d) An entity might make a payment to a third party that is expected to be a customer in a future period, but the entity receives an intangible asset in exchange for the payment (for example, the right to be the exclusive provider of a particular component of a key product of the third party).
The staff’s analysis in this Q&A does not apply to scenarios in which an entity sells goods or services to a customer at a loss with a strong expectation of profit on future orders from that customer. The staff’s analysis on upfront payments to customers should not be applied by analogy to scenarios in which an entity has a loss on the sale of inventory or another asset.
Consideration payable to a customer is excluded from the scope of the guidance in Subtopic 340-40, Other Assets and Deferred Costs—Contracts with Customers. Therefore, the staff’s analysis in this question does not relate to incremental costs of obtaining a contract or costs incurred in fulfilling a contract with a customer, which are within the scope of Subtopic 340-40.
The staff thinks that an entity will need to evaluate the facts and circumstances and make judgments about the nature of the payment. In the staff’s view, an important first step in evaluating the accounting for an upfront payment is understanding the reasons for the payment, the rights and obligations resulting from the payment (if any), the nature of the promise(s) in the contract (if any), and other relevant facts and circumstances. Understanding this rationale can be instructive when determining the accounting and in particular, understanding whether and how the entity expects to obtain future benefits as a result of the payment. In addition, this rationale can be helpful in deciding what information about the arrangement should be disclosed to financial statement users.
If the counterparty is a customer, paragraph 606-10-32-25 is clear that the payment should be recorded as a reduction of revenue, unless the payment to the customer is in exchange for a distinct good or service. If that payment relates entirely to the current contract with the customer, Topic 606 is clear on how the payment would be recognized. The consideration paid to a customer is accounted for as a reduction of the transaction price. The practical effect of this accounting is that:
(a) An entity will record an asset for the upfront payment. This asset essentially represents an advance of funds to the customer, which the entity recovers subsequently as related goods or services are performed.
(b) The payment is recognized as a reduction of revenue as the goods or services are transferred to the customer.
The TRG discussed the following circumstances in which the accounting is less straightforward than the scenario in the above paragraph:
(a) An entity makes an upfront payment to a customer (or a potential customer) and does not have a revenue contract (that is, there is not yet a contract to be accounted for under Topic 606). An entity might make an upfront payment in anticipation of future purchases from the customer.
(b) An entity makes an upfront payment to a customer and there is a revenue contract. However, the upfront payment relates to the current contract as well as anticipated future revenue contracts.
There are two views about the timing of when the reduction in revenue for an upfront payment should be recorded.
(a) View A—Payments to customers should be recognized as a reduction of revenue as the related goods or services (that is, the expected total purchases resulting from the upfront payment) are transferred to the customer. The payment might be recorded in the income statement over a period that is longer than the current legally enforceable contract. Identification of the related goods or services will require judgment on the basis of the facts and circumstances. The asset would be periodically assessed for recoverability.
(b) View B—Payments to customers should be recognized as a reduction of revenue from the existing contract (that is, existing enforceable rights and obligations). If no revenue contract exists, then the entire payment would be immediately recognized in the income statement.
TRG members observed that View A would be appropriate in many cases. TRG members agreed with the staff view that if an asset is recorded it should meet the definition of an asset in FASB Concepts Statement No. 6, Elements of Financial Statements, and an entity should assess whether the asset is impaired in subsequent reporting periods. However, TRG members agreed with the staff view that View B could be appropriate in some cases. TRG members agreed with the staff view that the accounting is not a policy election and agreed that an entity should understand the reasons for the payment, the rights and obligations resulting from the payment (if any), the nature of the promise(s) in the contract (if any), and other relevant facts and circumstances for each arrangement when determining the appropriate accounting. TRG members also agreed with the staff that the assessment will require significant judgment in some cases and appropriate disclosures in the financial statements might be important.
Copyright #year# by Financial Accounting Foundation, Norwalk, Connecticut.
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