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A change to an existing contract is a modification. A contract modification could change the scope of the contract, the price of the contract, or both. A contract modification exists when the parties to the contract approve the modification either in writing, orally, or based on the parties' customary business practices. Judgment will often be needed to determine whether changes to existing rights and obligations should have been accounted for as part of the original arrangement (that is, should have been anticipated due to the reporting entity's business practices) or accounted for as a contract modification. Refer to RR 7.2.2 for discussion of whether the exercise of a customer option that provides a material right should be accounted for as a contract modification or a continuation of the existing contract.
A new agreement with an existing customer could be a modification of an existing contract even if the agreement is not structured as a modification to the terms and conditions of the existing contract. For example, a vendor may enter into a contract to provide services to a customer over a two-year period. During the contract period, the vendor could enter into a new contract to provide different goods or services to the same customer. Management should assess whether the new contract is a modification to the existing contract. Factors to consider could include whether the terms and conditions of the new contract were negotiated separately from the original contract and whether the pricing of the new contract depends on the pricing of the existing contract. If the new contract transfers distinct goods or services to the customer that are priced at their standalone selling prices, the new contract would be accounted for separately (whether or not it is viewed as a contract modification). If the goods or services are priced at a discount to standalone selling price, management will need to evaluate the reason for the discount as this may be an indicator that the new contract is a modification of the existing contract.
An agreement to modify a contract could include adjustments to the transaction price of goods or services already transferred to the customer. For example, in connection with a contract modification, a reporting entity may agree to provide a partial refund due to customer satisfaction issues related to goods already delivered. The refund should be accounted for separately because it is an adjustment to the transaction price of the previously transferred goods. Thus, the amount of the refund would be recognized immediately as a reduction of revenue and excluded from the application of the modification guidance summarized in Figure RR 2-3. Determining when a portion of a price modification should be accounted for separately could require significant judgment. This concept is illustrated in Example 5, Case B, of the revenue standard (ASC 606-10-55-114 through ASC 606-10-55-116).
Contract modifications are accounted for as either a separate contract or as part of the existing contract, depending on the nature of the modification, as summarized in Figure RR 2-3.
Figure RR 2-3
Accounting for contract modifications

Refer to RR 2.9.3 for discussion of modifications that involve both goods and services that are distinct and those that are not distinct.

Question RR 2-5
A reporting entity and its customer agree to terminate an existing contract and enter into a new contract rather than modify the existing contract. Does the contract modification guidance apply in this situation?
PwC response
We believe management should apply the contract modification guidance to determine the appropriate accounting if, in substance, the parties have modified the existing contract even if it is structured as a termination of the existing contract and creation of a new contract.

2.9.1 Assessing whether a contract modification is approved

A contract modification is approved when the modification creates or changes the enforceable rights and obligations of the parties to the contract. Management will need to determine if a modification is approved either in writing, orally, or implied by customary business practices such that it creates enforceable rights and obligations before accounting for the modification. Management should continue to account for the existing terms of the contract until the modification is approved.
Where the parties to an arrangement have agreed to a change in scope, but not the corresponding change in price (for example, an unpriced change order), the reporting entity should estimate the change to the transaction price in accordance with the guidance on estimating variable consideration (refer to RR 4). Management should assess all relevant facts and circumstances (for example, prior experience with similar modifications) to determine whether there is an expectation that the price will be approved. Example RR 2-14 illustrates a contract modification with an unpriced change order. This concept is also illustrated in Example 9 of the revenue standard (ASC 606-10-55-134 through ASC 606-10-55-135).
EXAMPLE RR 2-14
Contract modifications – unpriced change order
Contractor enters into a contract with a customer to construct a warehouse. Contractor discovers environmental issues during site preparation that must be remediated before construction can begin. Contractor obtains approval from the customer to perform the remediation efforts, but the price for the services will be agreed to in the future (that is, it is an unpriced change order). Contractor completes the remediation and invoices the customer $2 million, based on the costs incurred plus a profit margin consistent with the overall expected margin on the project.
The invoice exceeds the amount the customer expected to pay, so the customer challenges the charge. Based on consultation with external counsel and the Contractor's customary business practices, Contractor concludes that performance of the remediation services gives rise to enforceable rights and that the amount charged is reasonable for the services performed.
Is the contract modification approved such that Contractor can account for the modification?
Analysis
Yes. Despite the lack of agreement on the specific amount Contractor will receive for the services, the contract modification is approved and Contractor can account for the modification. The scope of work has been approved; therefore, Contractor should estimate the corresponding change in transaction price in accordance with the guidance on variable consideration. Refer to RR 4 for further considerations related to the accounting for variable consideration, including the constraint on variable consideration.

2.9.2 Modification is accounted for as a separate contract

Accounting for a modification as a separate contract reflects the fact that there is no economic difference between the reporting entities entering into a separate contract or agreeing to modify an existing contract.

Excerpt from ASC 606-10-25-12

An entity shall account for a contract modification as a separate contract if both of the following conditions are present:
a. The scope of the contract increases because of the addition of promised goods or services that are distinct...
b. The price of the contract increases by an amount of consideration that reflects the entity's standalone selling prices of the additional promised goods or services and any appropriate adjustments to that price to reflect the circumstances of the particular contract. For example, an entity may adjust the standalone selling price of an additional good or service for a discount that the customer receives, because it is not necessary for the entity to incur the selling-related costs that it would incur when selling a similar good or service to a new customer.

The guidance provides some flexibility in what constitutes “standalone selling price” to reflect the specific circumstances of the contract. For example, a reporting entity might provide a discount to a recurring customer that it would not provide to new customers. The objective is to determine whether the pricing reflects the amount the reporting entity would have negotiated independent of other existing contracts.
Example RR 2-15 and Example RR 2-16 illustrate contract modifications that are accounted for as separate contracts. This concept is also illustrated in Example 5 of the revenue standard (ASC 606-10-55-111 through ASC 606-10-55-116).
EXAMPLE RR 2-15
Contract modifications – sale of additional goods
Manufacturer enters into an arrangement with a customer to sell 100 goods for $10,000 ($100 per good). The goods are distinct and are transferred to the customer over a six-month period. The parties modify the contract in the fourth month to sell an additional 20 goods for $95 each. The price of the additional goods represents the standalone selling price on the modification date.
Should Manufacturer account for the modification as a separate contract?
Analysis
Yes. The modification to sell an additional 20 goods at $95 each should be accounted for as a separate contract because the additional goods are distinct and the price reflects their standalone selling price. The existing contract would not be affected by the modification.
EXAMPLE RR 2-16
Contract modifications — blend-and-extend modification
Manufacturer enters into a three-year noncancellable contract to deliver 100 products each year at a fixed price of $90 per unit. Market prices for the products decline in the period following contract inception. At the end of the second year, when the market price is $80 per unit, the parties agree to modify the contract to: (1) extend the sales contract for an additional year (same fixed annual quantity); and (2) lower the sales price to a “blended” rate of $85 per unit for all remaining units ($90 x 100 remaining units from the original contract plus $80 x 100 additional units). Manufacturer concludes the products to be delivered in the future are distinct from those previously delivered and concludes the standalone selling price is $80 per unit.
How should Manufacturer account for the modification?
Analysis
The “blend-and-extend” modification allows the customer to immediately take advantage of a lower price; however, the substance of the modification in this fact pattern is that the parties agreed to add distinct goods for additional consideration that reflects standalone selling price. It may therefore be appropriate for Manufacturer to account for the modification as a separate contract. Under this approach, Manufacturer would continue to recognize revenue of $90 per unit for the remaining period of the original contract and recognize $80 per unit in the following year.
Management should consider all of the relevant facts and circumstances to determine whether the additional consideration reflects standalone selling price, which may require significant judgment. If the additional consideration does not reflect standalone selling price, the modification should be accounted for as the termination of the existing contract and creation of a new contract, and revenue would be recognized based on the blended price for all units. For example, the additional consideration may not reflect standalone selling price in situations when quantities are variable (as opposed to fixed), prices are expected to change significantly in the future (such that the standalone selling price for future years is expected to differ from the contract price), or the arrangement contains a significant financing component (to provide the benefit of advanced cash flow).

2.9.3 Modification is not a separate contract

A modification that does not meet both of the criteria to be accounted for as a separate contract is accounted for as an adjustment to the existing contract, either prospectively or through a cumulative catch-up adjustment. The determination depends on whether the remaining goods or services to be provided to the customer under the modified contract are distinct. In some cases, the remaining goods or services might include both (a) goods and services that are distinct from those transferred before the modification, and (b) goods and services that are not distinct. The revenue standard does not provide specific guidance in this situation, but states that effects of the modification should be accounted for in a manner consistent with the objectives in the modification guidance. That is, a reporting entity would apply a combination of the methods described in RR 2.9.3.1 and RR 2.9.3.2, which may require judgment.

2.9.3.1 Modification is accounted for prospectively

A reporting entity should account for a modification prospectively if the modification is not a separate contract (as described in RR 2.9.2), but the remaining goods or services are distinct from the goods or services transferred before the modification. This type of contract modification is effectively treated as the termination of the original contract and the creation of a new contract. The contract consideration is allocated to the remaining performance obligations after the modification, including any unsatisfied performance obligations from the original contract. The amount of allocated consideration is the sum of any unrecognized consideration initially included in the transaction price of the contract before the modification and any additional consideration promised as part of the modification. Allocation to the remaining performance obligations should be based on current standalone selling prices since the modification is treated as the creation of a new contract.
A reporting entity will also account for a contract modification prospectively if the contract contains a single performance obligation that comprises a series of distinct goods or services, such as a monthly cleaning service (refer to RR 3.3.2). In other words, the modification will only affect the accounting for the remaining distinct goods and services to be provided in the future, even if the series of distinct goods or services is accounted for as a single performance obligation.
Example RR 2-17 and Example RR 2-18 illustrate contract modifications accounted for prospectively. This concept is also illustrated in Example 7 of the revenue standard (ASC 606-10-55-125 through ASC 606-10-55-128).
EXAMPLE RR 2-17
Contract modifications – series of distinct services
ServeCo enters into a three-year noncancellable service contract with Customer for $450,000 ($150,000 per year). The standalone selling price for one year of service at inception of the contract is $150,000 per year. ServeCo accounts for the contract as a series of distinct services (refer to RR 3.3.2).
At the end of the second year, the parties agree to modify the contract as follows: (1) the fee for the third year is reduced to $120,000; and (2) Customer agrees to extend the contract for another three years for $300,000 ($100,000 per year). The standalone selling price for one year of service at the time of modification is $120,000.
How should ServeCo account for the modification?
Analysis
The modification would be accounted for as if the existing arrangement was terminated and a new contract created (that is, on a prospective basis) because the remaining services to be provided are distinct. The modification should not be accounted for as a separate contract, even though the remaining services to be provided are distinct, because the price of the contract did not increase by an amount of consideration that reflects the standalone selling price of the additional services.
ServeCo should reallocate the remaining consideration to all of the remaining services to be provided (that is, the obligations remaining from the original contract and the new obligations). ServeCo will recognize a total of $420,000 ($120,000 + $300,000) over the remaining four-year service period (one year remaining under the original contract plus three additional years), or $105,000 per year.
EXAMPLE RR 2-18
Contract modifications — modification accounted for on a prospective basis
Supplier enters into a noncancellable contract with Retailer to supply 100,000 goods on an annual basis for $3 per unit for three years. At the beginning of the third year, Supplier and Retailer agree to renegotiate the contract because the market price for the goods has declined. Under the modified agreement, the parties agree to (1) extend the contract for an additional year (same fixed annual quantity) and (2) reduce the price per unit to $2 for the remaining 200,000 units to be delivered. Supplier also agrees as part of the modification to make a one-time payment of $10,000 to Retailer. There is no dispute between the parties regarding prior performance, and both parties have performed according to the terms of the contract.
Supplier concludes the remaining goods are distinct from those previously delivered and concludes the additional consideration does not reflect standalone selling price.
How should Supplier account for the modification?
Analysis
Supplier should account for the modification on a prospective basis. The transaction price of $390,000 ($2 per unit x 200,000 remaining goods less $10,000 payment to Retailer) should be allocated to the remaining performance obligations, resulting in revenue of $1.95 per unit ($390,000 / 200,000 goods). The $10,000 payment to Retailer is a reduction of the transaction price allocated to the remaining goods in this fact pattern because the payment was made in conjunction with the renegotiation of the contract and there is no indication that the payment relates to prior performance.
In contrast, if there was evidence of a dispute or failure to perform according to the contract terms related to the previously delivered goods, this might indicate that Supplier agreed to make a concession that reduces the transaction price for the previously delivered goods. In that case, the amount that represents a concession would be recorded immediately. Determining when a portion of a modification is in substance a price concession could require significant judgment. This concept is illustrated in Example 5, Case B of the revenue standard (ASC 606-10-55-114 through ASC 606-10-55-116).

Question RR 2-6
Should an existing contract asset be written off as a reduction of revenue when a modification is accounted for as the termination of the original contract and creation of a new contract?
PwC response
Generally, no. Although the original contract is considered “terminated,” modifications of this type should be accounted for on a prospective basis. That is, the contract asset would typically relate to a right to consideration for goods and services that have already been transferred. Management should consider, however, whether the facts and circumstances of the modification result in an impairment of the contract asset. Refer to US Revenue TRG Memo No. 51 and the related meeting minutes in Revenue TRG Memo No. 55 for further discussion of this topic.

2.9.3.2 Modification results in a cumulative catch-up adjustment

A reporting entity accounts for a modification through a cumulative catch-up adjustment if the remaining goods or services after the modification are not distinct from the goods or services transferred prior to the modification. For example, this guidance would apply to a contract that contains a single performance obligation and is modified when the performance obligation is partially satisfied. A reporting entity first updates the measure of progress and transaction price of the contract based on changes to scope or price as a result of the modification. The cumulative catch-up adjustment is calculated by applying the revised measure of progress to the revised transaction price, which could result in an immediate increase to or a reduction of revenue in the period of the modification. This concept is illustrated in Example 8 of the revenue standard (ASC 606-10-55-129 through ASC 606-10-55-133).
Modifications of contracts that include a single performance obligation that is a series of distinct goods or services will not be accounted for using a cumulative catch-up adjustment; rather, these modifications will be accounted for prospectively (refer to RR 2.9.3.1).
Example RR 2-19 illustrates a contract modification accounted for through a cumulative catch-up adjustment.
EXAMPLE RR 2-19
Contract modifications – cumulative catch-up adjustment
Builder enters into a two-year arrangement with Customer to build a manufacturing facility for $300,000. The construction of the facility is a single performance obligation. Builder and Customer agree to modify the original floor plan at the end of the first year, which will increase the transaction price and expected cost by approximately $100,000 and $75,000, respectively.
How should Builder account for the modification?
Analysis
Builder should account for the modification as if it were part of the original contract. The modification does not create a performance obligation because the remaining goods and services to be provided under the modified contract are not distinct. Builder should update its estimate of the transaction price and its measure of progress to account for the effect of the modification. This will result in a cumulative catch-up adjustment at the date of the contract modification.

2.9.4 Changes in the transaction price

A contract modification that only affects the transaction price is either accounted for prospectively or on a cumulative catch-up basis. It is accounted for prospectively if the remaining goods or services are distinct. There is a cumulative catch-up if the remaining goods or services are not distinct. Thus, a contract modification that only affects the transaction price is accounted for like any other contract modification.
The transaction price might also change as a result of changes in circumstances or the resolution of uncertainties. Changes in the transaction price that do not arise from a contract modification are addressed in RR 4.3.4 and RR 5.5.2.
The accounting can be complex if the transaction price changes as a result of a change in circumstances or changes in variable consideration after a contract has been modified. The revenue standard provides guidance and an example to address this situation.

Excerpt from ASC 606-10-32-45

a. An entity shall allocate the change in the transaction price to the performance obligations identified in the contract before the modification if, and to the extent that, the change in the transaction price is attributable to an amount of variable consideration promised before the modification and the modification is accounted for [as if it were a termination of the existing contract and the creation of a new contract].
b. In all other cases in which the modification was not accounted for as a separate contract…, an entity shall allocate the change in the transaction price to the performance obligations in the modified contract (that is, the performance obligations that were unsatisfied or partially unsatisfied immediately after the modification).

Example 6 in the revenue standard (ASC 606-10-55-117 through ASC 606-10-55-124) illustrates the accounting for a change in the transaction price after a contract modification.


2.9.5 Modifications that reduce the scope of a contract

As described in RR 2.9.2, a modification is accounted for as a separate contract only if distinct goods or services are added to the contract for a price equal to standalone selling price (adjusted for contract-specific circumstances). Modifications that reduce the scope of a contract would not be accounted for as a separate contract because they do not solely add distinct goods or services to the contract. Therefore, the accounting for a modification that reduces the scope of a contract depends on whether the remaining goods or services are distinct from the goods or services transferred before the modification:
  • If the remaining goods or services are distinct (including goods or services that are part of a series), the modification is accounted for prospectively as if it were a termination of the existing contract and creation of a new contract. Refer to RR 2.9.3.1.
  • If the remaining goods or services are not distinct (for example, a single performance obligation is being modified), the modification is accounted for on a cumulative catch-up basis. Refer to RR 2.9.3.2.

Question RR 2-7
It is common for vendors to receive a one-time payment from a customer as consideration for reducing the scope of a contract (e.g., reducing the term or volume of committed purchases). Should a reporting entity recognize these one-time payments as revenue on the contract modification date?
PwC response
Typically, no. Although these payments are sometimes labeled “termination payments,” the modification guidance should be applied because the contract has not been terminated:
  • If the modification is accounted for prospectively, the payment is included in the contract consideration allocated to the remaining performance obligations after the modification. In other words, the payment is recognized as revenue as the remaining goods or services are transferred.
  • If the modification is accounted for on a cumulative catch-up basis, the payment is included in the revised transaction price used to calculate the cumulative catch-up adjustment.
If the modification arises from a dispute such as a claim for additional consideration related to past performance, the reporting entity might conclude that all or a portion of the payment relates to goods or services transferred before the modification. In this situation, the reporting entity would recognize revenue immediately for the portion of the payment attributable to goods or services previously transferred to the customer.

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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