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Reporting entities sometimes incur costs to obtain a contract with a customer, such as selling and marketing costs, bid and proposal costs, sales commissions, and legal fees. Costs to obtain a customer do not include payments to customers; refer to RR 4.6 for discussion of payments to customers.

Excerpt from ASC 340-40-25-1

An entity shall recognize as an asset the incremental costs of obtaining a contract with a customer if the entity expects to recover those costs.

Only incremental costs should be recognized as assets. Incremental costs of obtaining a contract are those costs that the reporting entity would not have incurred if the contract had not been obtained (for example, sales commissions). Bid, proposal, and selling and marketing costs (including advertising costs), as well as legal costs incurred in connection with the pursuit of the contract, are not incremental, as the reporting entity would have incurred those costs even if it did not obtain the contract. Fixed salaries of employees are also not incremental because those salaries are paid regardless of whether a sale is made.
A reporting entity could make payments to multiple individuals for the same contract that all qualify as incremental costs. For example, if a reporting entity pays a sales commission to the salesperson, manager, and regional manager upon obtaining a new contract, all of the payments would be incremental costs.
The timing of a payment does not on its own determine whether the costs are incremental; however, management should consider whether the payment is contingent upon factors other than obtaining a contract. For example, a bonus payment that is calculated based on obtaining contracts is similar to a commission, but if the bonus is also based on the individual's overall performance in relation to non-sales-related goals, it is likely not an incremental cost. Similarly, a payment that is contingent upon an employee providing future service in addition to obtaining a new contract would generally not be considered an incremental cost to obtain a contract. Assessing whether a payment has a substantive future service requirement may require judgment. Refer to US Revenue TRG Memo No. 57 and the related meeting minutes in Revenue  TRG Memo No. 60 for further discussion of costs that are incremental.
Costs of obtaining a contract that are not incremental should be expensed as incurred unless those costs are explicitly chargeable to the customer, even if the contract is not obtained. Amounts that relate to a contract that are explicitly chargeable to a customer are a receivable if a reporting entity’s right to reimbursement is unconditional.
Incremental costs of obtaining a contract with a customer are recognized as assets if they are recoverable. Expensing these costs as they are incurred is not permitted unless they qualify for the practical expedient discussed at RR 11.2.2.
The revenue standard does not address the timing for recognizing a liability for costs to obtain a contract. Management should therefore refer to the applicable liability guidance (for example, ASC 405, Liabilities) to first determine if the reporting entity has incurred a liability and then apply the revenue standard to determine whether the related costs should be capitalized or expensed. Refer to Revenue  TRG Memo No. 23 and the related meeting minutes in Revenue TRG Memo No. 25  for further discussion of this topic.

In some cases, incremental costs may relate to multiple contracts. For example, many sales commission plans are designed to pay commissions based on cumulative thresholds. The fact that the costs relate to multiple contracts does not preclude the costs from qualifying as incremental costs to obtain a contract. Management should apply judgment to determine a reasonable approach to allocate costs to the related contracts in these instances. Refer to Revenue TRG Memo No. 23, US Revenue TRG Memo No. 57, and the related meeting minutes in Revenue TRG Memo No. 25 and Revenue TRG Memo 60, respectively, for further discussion of this topic.
Question RR 11-2 addresses whether fringe benefits represent incremental costs to obtain a contract.
Question RR 11-2
Do fringe benefits (for example, payroll taxes) related to commission payments represent incremental costs to obtain a contract?
PwC response
Yes, if the fringe benefits would not have been incurred if the contract had not been obtained. Fringe benefits that are incremental costs and recoverable (refer to RR 11.2.1) are required to be capitalized, unless they qualify for the practical expedient discussed at RR 11.2.2. Refer to Revenue TRG Memo No. 23 and the related meeting minutes in Revenue TRG Memo No. 25  for further discussion of this topic.

Question RR 11-3 addresses the accounting for incremental costs to obtain contract renewals or modifications.
Question RR 11-3
Should incremental costs to obtain contract renewals or modifications be capitalized?
PwC response
Yes, if the costs to obtain contract renewals or modification are incremental and recoverable. An example is a commission paid to a sales agent when a customer renews a contract. Management should not, however, record an asset in anticipation of contract renewals or modifications if the reporting entity has not yet incurred a liability related to the costs. Refer to Revenue TRG Memo No. 23 and the related meeting minutes in Revenue TRG Memo No. 25 for further discussion of this topic.

Question RR 11-4 addresses whether a sales commission should be capitalized if it is subject to clawback.
Question RR 11-4
Should a sales commission be capitalized if it is subject to clawback in the event the customer fails to pay the contract consideration?
PwC response
Yes, assuming management has concluded that the parties are committed to perform their respective obligations and collection is probable, which are requirements for identifying a contract (refer to RR 2.6.1). Management should reassess whether a valid contract exists if circumstances change after contract inception and assess the contract asset for impairment. Refer to Revenue TRG Memo No. 23 and the related meeting minutes in Revenue TRG Memo No. 25 for further discussion of this topic.

11.2.1 Assessing recoverability

Management should assess recoverability of the incremental costs of obtaining a contract either on a contract-by-contract basis, or for a group of contracts if those costs are associated with the group of contracts. Management may be able to support the recoverability of costs for a particular contract based on its experience with other transactions if those transactions are similar in nature.
Management should consider, as part of its recoverability assessment, estimates of expected consideration from potential renewals and extensions. This should include both consideration received but not yet recognized as revenue and consideration the reporting entity is expected to receive in the future. Variable consideration that is constrained for revenue recognition purposes should also be included in assessing recoverability. Costs that are not expected to be recoverable should be expensed as incurred. See RR 11.4.2 for additional discussion of impairment.

11.2.2 Practical expedient

There is a practical expedient that permits a reporting entity to expense the costs to obtain a contract as incurred when the expected amortization period is one year or less. Anticipated contract renewals, amendments, and follow-on contracts with the same customer are required to be considered (to the extent the costs relate to those goods or services) when determining whether the period of benefit, and therefore the period of amortization, is one year or less. These factors might result in an amortization period that is beyond one year, in which case the practical expedient is not available.
Question RR 11-5 addresses whether the practical expedient can be applied to an individual contract.
Question RR 11-5
Can a reporting entity elect whether to apply the practical expedient to each individual contract or is it required to apply the election consistently to all similar contracts?
PwC response
The practical expedient is an accounting policy election that should be applied consistently to similar contracts.

11.2.3 Recognition model overview and examples

Figure RR 11-1 summarizes the accounting for incremental costs to obtain a contract.
Figure RR 11-1
Costs to obtain a contract overview
Example RR 11-1, Example RR 11-2, Example RR 11-3, Example RR 11-4, and Example RR 11-5 illustrate the accounting for incremental costs to obtain a contract. These concepts are also illustrated in Examples 36 and 37 of the revenue standard (ASC 606-10-55-281 through ASC 606-10-55-282).
EXAMPLE RR 11-1
Incremental costs of obtaining a contract – practical expedient
A salesperson for ProductCo earns a 5% commission on a contract that was signed in January. ProductCo will deliver the purchased products throughout the year. The contract is not expected to be renewed the following year. ProductCo expects to recover this cost.
How should ProductCo account for the commission?
Analysis
ProductCo can either recognize the commission payment as an asset or expense the cost as incurred under the practical expedient. The commission is a cost to obtain a contract that would not have been incurred had the contract not been obtained. Since ProductCo expects to recover this cost, it can recognize the cost as an asset and amortize it as revenue is recognized during the year. The commission payment can also be expensed as incurred because the amortization period of the asset is one year or less.
The practical expedient would not be available; however, if management expects the contract to be renewed such that products will be delivered over a period longer than one year, as the amortization period of the asset would also be longer than one year.
EXAMPLE RR 11-2
Incremental costs of obtaining a contract – construction industry
ConstructionCo incurs costs in connection with winning a successful bid on a contract to build a bridge. The costs were incurred during the proposal and contract negotiations, and include the initial bridge design.
How should ConstructionCo account for the costs?
Analysis
ConstructionCo should expense the costs incurred during the proposal and contract negotiations as incurred. The costs are not incremental because they would have been incurred even if the contract was not obtained. The costs incurred during contract negotiations could be recognized as an asset if they are explicitly chargeable to the customer regardless of whether the contract is obtained.
Even though the costs incurred for the initial design of the bridge are not incremental costs to obtain a contract, some of the costs might be costs to fulfill a contract and recognized as an asset under that guidance (refer to RR 11.3).
EXAMPLE RR 11-3
Incremental costs of obtaining a contract – telecommunications industry
Telecom sells wireless mobile phone and other telecom service plans from a retail store. Sales agents employed at the store signed 120 customers to two-year service contracts in a particular month. Telecom pays its sales agents commissions for the sale of service contracts in addition to their salaries. Salaries paid to sales agents during the month were $12,000, and commissions paid were $2,400. The retail store also incurred $2,000 in advertising costs during the month.
How should Telecom account for the costs?
Analysis
The only costs that qualify as incremental costs of obtaining a contract are the commissions paid to the sales agents. The commissions are costs to obtain a contract that Telecom would not have incurred if it had not obtained the contracts. Telecom should record an asset for the costs, assuming they are recoverable.
All other costs are expensed as incurred. The sales agents' salaries and the advertising expenses are expenses Telecom would have incurred whether or not it obtained the customer contracts.
EXAMPLE RR 11-4
Incremental costs of obtaining a contract — bonus based on a revenue target
TechCo's vice president of sales receives a quarterly bonus based on meeting a specified revenue target that is established at the beginning of each quarter. TechCo's revenue includes revenue from both new contracts initiated during the quarter and contracts entered into in prior quarters.
Is the bonus an incremental cost to obtain a contract?
Analysis
No. The revenue target is impacted by more than obtaining new contracts. As such, the payment would not be an incremental cost to obtain the contract.
If the revenue target was based on obtaining new contracts, the substance of the payment would be the same as a sales commission. If this were the case, the bonus might be an incremental cost.
EXAMPLE RR 11-5
Incremental costs of obtaining a contract — payment requires future service
Employee A, an internal salesperson employed by ProductCo, earns a 5% commission on a new contract obtained in January 20X1. The commission plan requires Employee A to continue providing employee service through the end of 20X2 to receive the commission payment.
Is the payment an incremental cost to obtain a contract?
Analysis
No. Employee A has to provide future service to receive the payment; therefore, the payment is contingent upon factors other than obtaining new contracts. ProductCo would recognize the expense over the service period in accordance with ASC 710, Compensation.
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