Entities sometimes commence activities on a specific anticipated contract either (a) before agreeing to the contract with the customer or (b) before the contract with the customer satisfying the criteria in Topic 606 to apply the general revenue recognition model.

For convenience, in this Q&A the date on which the criteria in paragraph 606-10-25-1 are satisfied is referred to as the “Contract Establishment Date (CED)” and the activities that an entity performs before the CED are referred to as “pre-CED activities.”

These pre-CED activities may be:

The question that arises is how to account for the revenue from the pre-CED activities that result in the transfer of a good or service to the customer as at the CED. The analysis in this Q&A is relevant only when the entity concludes that a contract has not been identified for the purposes of Topic 606 before the CED.

The staff’s view is that revenue should be recognized on a cumulative catch-up basis, reflecting the performance obligation(s) that are partially satisfied or satisfied as at the CED. It is the staff’s view that it would not be appropriate to recognize revenue on a prospective basis beginning on the CED.

The staff notes that the core principle of the standard as set out in paragraph 606-10-10-2 is to “recognize revenue to depict the transfer of promised goods or services to customers. . . .” If an entity has transferred promised goods or services within a performance obligation to the customer at the CED, the staff thinks that it is appropriate and consistent with that core principle that the entity should recognize revenue to reflect the promised goods or services already transferred to the customer at the CED. In other words, revenue should be recognized on a cumulative catch-up basis, reflecting the performance obligation(s) that are partially satisfied or satisfied as at the CED.

A cumulative catch-up adjustment is consistent with the overall principle of recognizing revenue to depict an entity’s performance in transferring control of goods or services to the customer (i.e. the satisfaction of an entity’s performance obligation). Hence, if the entity concludes, in accordance with Topic 606, that the pre-CED activities have resulted in progress towards satisfying a performance obligation as at the CED, it would recognize the revenue to which it expects to be entitled for that progress. A cumulative catch-up adjustment reflects the fact that control of a portion of the good or service has transferred to the customer at the CED. In assessing whether the pre-CED activities result in the transfer of control of a good or service, an entity would consider the requirements in paragraphs 606-10-25-23 through 25-30.

Paragraph 606-10-25-35 states that “As circumstances change over time, an entity shall update its measure of progress to reflect any changes in the outcome of the performance obligation. Such changes to an entity’s measure of progress shall be accounted for as a change in accounting estimate. . . .” Changes in accounting estimate are recognized in the period of change unless they affect future periods in accordance with Topic 250, Accounting Changes and Error Corrections.

In paragraph BC48 of Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606), the Board noted that the requirements in paragraph 606-10-25-7 are “similar to the ‘deposit method’ that was previously included in GAAP and that was applied when there was no consummation of a sale.” Under current GAAP, entities recognize revenue (and interest income) on a cumulative catch-up basis when they subsequently apply the full accrual method after applying the deposit method (paragraph 360-20-55-17). It could be analogized from this guidance that an entity applying Topic 606 could recognize revenue as at the CED arising from pre-CED activities on a cumulative catch-up basis.

When the subject matter of a contract is established between the entity and the customer, the underlying performance obligations do not differ depending on whether the entity commences activities, for example, manufacturing or constructing goods, before or after the CED. The extent of progress towards satisfying the performance obligation(s) for which the customer has contracted is the same.

The staff notes that applying a cumulative catch-up adjustment to a contract which does not satisfy the criteria in paragraph 606-10-25-1 until the CED would result in the same cumulative recognition of revenue at the CED and in future periods, and hence the same contract asset or contract liability position, as a contract that had met the criteria in paragraph 606-10-25-9 before the CED. From the CED, the two projects will be identical and hence economically equivalent. Therefore, a cumulative catch-up basis will better reflect the contract and so provide users of the financial statements with more decision-useful information than a prospective basis beginning on the CED. Under a prospective basis, the pattern of revenue recognition would be different after the CED, despite the two contracts being economically equivalent.

The staff considers that the Board’s intention on this point is more clearly demonstrated in the reference quoted in the discussion above to paragraph BC48 of Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606), referring to the guidance in Topic 606 being similar to the ‘deposit method’ under current GAAP, where revenue is recognized on a cumulative catch-up basis.

The staff therefore considers that a cumulative catch-up basis best satisfies the core principle in paragraph 606-10-10-2 that ‘an entity shall recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services’ and is therefore the appropriate method of measuring progress at the point paragraph 606-10-25-1 is satisfied, that is, the CED.

In applying a cumulative catch-up basis, an entity should consider the requirements in paragraphs 606-10-25-23 through 25-37 to determine the goods or services which the customer controls and therefore what portion of pre-CED costs should be included in any measure of progress towards satisfaction of a performance obligation that is used to calculate the cumulative catch-up adjustment. For example, if the pre-CED costs relate to uninstalled materials that the customer does not control, the inclusion of those costs in determining how much revenue to recognize might not be appropriate.