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11.4 Amortization and impairment
Publication date: 30 Nov 2023
us Revenue guide
The revenue standard provides guidance on the subsequent accounting for contract cost assets, including amortization and periodic assessment of the asset for impairment.
11.4.1 Amortization of contract cost assets
The asset recognized from capitalizing the costs to obtain or fulfill a contract is amortized on a systematic basis consistent with the pattern of the transfer of the goods or services to which the asset relates. Judgment may be required to determine the goods or services to which the asset relates. Capitalized costs might relate to an entire contract, or could relate only to specific performance obligations within a contract.
Capitalized costs could also relate to anticipated contracts, such as renewals. An asset recognized for contract costs should be amortized over a period longer than the initial contract term if management anticipates a customer will renew a contract and the costs also relate to goods or services that are expected to be transferred during renewal periods. An appropriate amortization period could be the average customer life or a shorter period, depending on the facts and circumstances. For example, a period shorter than the average customer life may be appropriate if the average customer life is longer than the life cycle of the related goods or services. Judgment will be required to determine the appropriate amortization period, similar to other tangible and intangible assets.
The amortization period should not include anticipated renewals if the reporting entity also incurs a similar cost for renewals. In that situation, the costs incurred to obtain the initial contract do not relate to the subsequent contract renewal. Assessing whether costs incurred for contract renewals are “commensurate with” costs incurred for the initial contract could require judgment. For example, reporting entities often pay a higher sales commission for initial contracts as compared to renewal contracts. The assessment of whether the renewal commission is commensurate with the initial commission should not be based on the level of effort required to obtain the initial and renewal contracts. Instead, it should generally be based on whether the initial and renewal commissions are reasonably proportional to the respective contract values. Refer to US Revenue TRG Memo No. 57 and the related meeting minutes in Revenue TRG Memo No. 60 for further discussion of this topic.
Management should apply an amortization method that is consistent with the pattern of transfer of goods or services to the customer. An asset related to an obligation satisfied over time should be amortized using a method consistent with the method used to measure progress and recognize revenue (that is, an input or output method). Straight-line amortization may be appropriate if goods or services are transferred to the customer ratably throughout the contract, but not if the goods or services do not transfer ratably.
A reporting entity should update the amortization of a contract asset if there is a significant change in the expected pattern of transfer of the goods or services to which the asset relates. Such a change is accounted for as a change in accounting estimate.
Question RR 11-7
How should reporting entities classify the amortization of capitalized costs to obtain a contract?
How should reporting entities classify the amortization of capitalized costs to obtain a contract?
PwC response
Whether costs are capitalized or expensed generally does not impact classification. For example, if similar types of costs are presented as sales and marketing costs, then the amortization of the capitalized asset would also typically be presented as sales and marketing.
Example RR 11-8, Example RR 11-9, Example RR 11-10, Example RR 11-11, and Example RR 11-12 illustrate the amortization of contract cost assets.
EXAMPLE RR 11-8
Amortization of contract cost assets — renewal periods without additional commission
Telecom sells prepaid wireless services to a customer. The customer purchases up to 1,000 minutes of voice services and any unused minutes expire at the end of the month. The customer can purchase an additional 1,000 minutes of voice services at the end of the month or once all the voice minutes are used. Telecom pays commissions to sales agents for initial sales of prepaid wireless services, but does not pay a commission for subsequent renewals. Telecom concludes the commission payment is an incremental cost of obtaining the contract and recognizes an asset.
The contract is a one-month contract and Telecom expects the customer, based on the customer’s demographics (for example, geography, type of plan, and age), to renew for 16 additional months.
What period should Telecom use to amortize the commission costs?
Analysis
Telecom should amortize the costs to obtain the contract over 17 months in this example (the initial contract term and expected renewal periods). Management needs to use judgment to determine the period that the reporting entity expects to provide services to the customer, including expected renewals, and amortize the asset over that period. In this fact pattern, Telecom cannot expense the commission payment under the practical expedient because the amortization period is greater than one year.
EXAMPLE RR 11-9
Amortization of contract cost assets — renewal periods with separate commission
Telecom sells prepaid wireless services to a customer. The customer purchases up to 1,000 minutes of voice services and any unused minutes expire at the end of the month. The customer can purchase an additional 1,000 minutes of voice services at the end of the month or once all the voice minutes are used. Telecom pays commissions to sales agents for initial sales of prepaid wireless services and renewals. Telecom concludes the commission payment is an incremental cost of obtaining the contract and recognizes an asset.
What period should Telecom use to amortize the commission costs?
Analysis
Telecom should assess whether the commission paid on the initial contract relates only to the goods or services provided under the initial contract or to both the initial and renewal periods. If Telecom concludes the renewal commission is commensurate with the commission paid on the initial contract, this would indicate that the initial commission relates only to the initial contract and should be amortized over the initial contract period (unless Telecom elects to apply the practical expedient). The renewal commission would be amortized over the related renewal period.
EXAMPLE RR 11-10
Amortization of contract cost assets – amortization method
ConstructionCo enters into a construction contract to build an oil refinery. ConstructionCo concludes that its performance creates an asset that the customer controls and that control is transferred over time. ConstructionCo also concludes that “cost-to-cost” is a reasonable method for measuring its progress toward satisfying its performance obligation.
ConstructionCo pays commissions totaling $100,000 to its sales agent for securing the oil refinery contract. ConstructionCo concludes that the commission is an incremental cost of obtaining the contract and recognizes an asset. As of the end of the first year, ConstructionCo estimates its performance is 50% complete and recognizes 50% of the transaction price as revenue.
How much of the contract asset should be amortized as of the end of the first year?
Analysis
The pattern of amortization should be consistent with the method ConstructionCo uses to measure progress toward satisfying its performance obligation for recognizing revenue. ConstructionCo should amortize 50%, or $50,000, of the commission costs as of the end of the first year.
EXAMPLE RR 11-11
Amortization of contract cost assets – multiple performance obligations
EquipCo enters into a contract with a customer to sell a piece of industrial equipment for $75,000 and provide two years of maintenance services for the equipment for $25,000. EquipCo concludes that the promises to transfer equipment and perform maintenance are distinct and, therefore, represent separate performance obligations. The contract price represents standalone selling price of the equipment and services.
EquipCo recognizes revenue for the sale of equipment when control of the asset transfers to the customer upon delivery. Revenue from the maintenance services is recognized ratably over two years consistent with the period during which the customer receives and consumes the maintenance services.
EquipCo pays a single commission of $10,000 to its sales agent equal to 10% of the total contract price of $100,000. EquipCo concludes that the commission is an incremental cost of obtaining the contract and recognizes an asset. Assume EquipCo does not expect the customer to renew the maintenance services.
What pattern of amortization should EquipCo use for the capitalized costs?
Analysis
EquipCo should use a reasonable method to amortize the asset consistent with the transfer of the goods or services. One acceptable approach would be to allocate the contract asset to each performance obligation based on relative standalone selling prices, similar to the allocation of transaction price. Applying this approach, EquipCo would allocate $7,500 of the total commission to the equipment and the remaining $2,500 to the maintenance services. The commission allocated to the equipment would be expensed upon transfer of control the equipment and the commission allocated to the services would be amortized over time consistent with the transfer of the maintenance services.
Other approaches could be acceptable if they are consistent with the pattern of transfer of the goods or services related to the asset. It would not be acceptable to amortize the entire asset on a straight-line basis in this example if the asset relates to both the equipment and the services. EquipCo could also consider whether there is evidence that would support a conclusion that the contract asset relates only to one of the performance obligations in the contract.
EXAMPLE RR 11-12
Amortization of contract cost assets – renewal commissions are not commensurate with initial commissions
ServiceCo pays an internal sales employee a $500 commission for selling an initial annual service contract to Customer A. ServiceCo will also pay a $250 commission for each annual renewal. The services provided under the initial and renewal contracts are substantially the same and the annual fee is the same. ServiceCo expects Customer A to renew the contract. ServiceCo concludes that the $500 commission is an incremental cost to obtain the contract and records an asset. ServiceCo also concludes that a five-year average customer life is an appropriate amortization period.
What pattern of amortization should ServiceCo use for the capitalized costs?
Analysis
The initial commission should be amortized over a period longer than the initial contract term because the renewal commission is not commensurate with the initial commission, indicating that a portion of the initial commission relates to services provided during renewal periods. The asset should be amortized on a systematic basis that is consistent with the transfer of the related services. To comply with this objective, ServiceCo could amortize the initial $500 commission over the average customer life of five years, or it could separate the initial commission of $500 into two components and amortize $250 over the initial annual contract term and the remaining $250 over the average customer life of five years. Other approaches could be acceptable if they are consistent with the pattern of transfer of the services related to the asset.
11.4.2 Impairment of contract cost assets
Assets recognized from the costs to obtain or fulfill a contract are subject to impairment testing. The impairment guidance should be applied in the following order:
- Impairment guidance for specific assets (for example, inventory)
- Impairment guidance for contract costs under the revenue standard
- Impairment guidance for asset groups or reporting units
Excerpt from ASC 340-40-35-3
An entity shall recognize an impairment loss in profit or loss to the extent that the carrying amount of an asset… exceeds:
- The amount of consideration that the entity expects to receive in the future and that the entity has received but not yet recognized as revenue, in exchange for the goods or services to which the asset relates (“the consideration”), less
- The costs that relate directly to providing those goods or services and that have not been recognized as expenses…
The amount of consideration the reporting entity expects to receive (and has received but not yet recognized as revenue) should be determined based on the transaction price and adjusted for the effects of the customer’s credit risk. Management should also consider expected contract renewals and extensions (with the same customer) in addition to any variable consideration that has not been included in the transaction price due to the constraint (refer to RR 4). Previously recognized impairment losses cannot be reversed.
Example RR 11-13 illustrates the impairment test for a contract cost asset.
EXAMPLE RR 11-13
Impairment of contract cost assets
DataCo enters into a two-year contract with a customer to build a data center in exchange for consideration of $1,000,000. DataCo incurs incremental costs to obtain the contract and costs to fulfill the contract that are recognized as assets and amortized over the expected period of benefit.
The economy subsequently deteriorates and the parties agree to renegotiate the pricing in the contract, resulting in a modification of the contract terms. The remaining amount of consideration to which DataCo expects to be entitled is $650,000. The carrying value of the asset recognized for contract costs is $600,000. An expected cost of $150,000 would be required to complete the data center.
How should DataCo account for the asset after the contract modification?
Analysis
DataCo should recognize an impairment loss of $100,000. The carrying value of the asset recognized for contract costs ($600,000) exceeds the remaining amount of consideration to which the reporting entity expects to be entitled less the costs that relate directly to providing the data center ($650,000 less $150,000). Therefore, an impairment loss of that amount is recognized.
This conclusion assumes that the reporting entity previously recognized any necessary impairment loss for inventory or other assets related to the contract prior to recognizing an impairment loss under the revenue standard. Impairment of other assets could impact the remaining costs required to complete the data center.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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