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3.2 Promises in a contract
Publication date: 31 Mar 2024
us Revenue guide
Promises in a contract can be explicit, or implicit if the promises create a valid expectation that the reporting entity will provide a good or service based on the reporting entity’s customary business practices, published policies, or specific statements. It is therefore important to understand a reporting entity’s policies and practices, representations made during contract negotiations, marketing materials, and business strategies when identifying the promises in an arrangement.
Promised goods or services include, but are not limited to:
- Transferring produced goods or reselling purchased goods
- Arranging for another party to transfer goods or services
- Standing ready to provide goods or services in the future (refer to RR 3.2.3)
- Building, designing, manufacturing, or creating an asset on behalf of a customer
- Granting a right to use or access to intangible assets, such as intellectual property (refer to RR 9.5)
- Granting an option to purchase additional goods or services that provides a material right to the customer (refer to RR 3.5)
- Performing contractually agreed-upon tasks
3.2.1 Immaterial promises
The revenue standard states that a reporting entity is not required to separately account for promised goods or services that are immaterial in the context of the contract.
An entity is not required to assess whether promised goods or services are performance obligations if they are immaterial in the context of the contract with the customer. If the revenue related to a performance obligation that includes goods or services that are immaterial in the context of the contract is recognized before those immaterial goods or services are transferred to the customer, then the related costs to transfer those goods or services shall be accrued.
An entity shall not apply the guidance in paragraph 606-10-25-16A to a customer option to acquire additional goods or services that provides the customer with a material right, in accordance with paragraphs 606-10-55-41 through 55-45.
Assessing whether promised goods or services are immaterial in the context of the contract requires judgment. Management should consider the nature of the contract and the relative significance of a particular promised good or service to the arrangement as a whole. Management should evaluate both quantitative and qualitative factors, including the customer’s perspective, in this assessment. For example, if a promised good or service is featured prominently in the reporting entity’s marketing materials, this likely indicates that the good or service is not immaterial from the customer's perspective. If multiple goods or services are considered to be individually immaterial in the context of the contract, but those items are material in the aggregate, management should not disregard those goods or services when identifying performance obligations.
If revenue is recognized prior to transferring immaterial goods or services, the related costs should be accrued. The requirement to accrue costs related to immaterial promises only applies to items that are, in fact, promises to the customer. For example, costs that will be incurred to operate a call desk that is broadly available to answer questions about a product would typically not be accrued as this activity would not fulfill a promise to a customer.
3.2.2 Implicit promises
The customer's perspective should be considered when assessing whether an implicit promise gives rise to a performance obligation. Customers might make current purchasing decisions based on expectations implied by a reporting entity’s customary business practices or marketing activities. A performance obligation exists if there is a valid expectation, based on the facts and circumstances, that additional goods or services will be delivered for no additional consideration.
Customers develop their expectations based on written contracts, customary business practices of certain reporting entities, expected behaviors within certain industries, and the way products are marketed and sold. Customary business practices vary between reporting entities, industries, and jurisdictions. They also vary between classes of customers, nature of the product or service, and other factors. Management will therefore need to consider the specific facts and circumstances of each arrangement to determine whether implied promises exist.
Implied promises made by the reporting entity to the customer in exchange for the consideration promised in the contract do not need to be enforceable by law in order for them to be evaluated as a performance obligation. This is in contrast to optional customer purchases in exchange for additional consideration, which are not included as performance obligations in the current contract unless the customer option provides a material right (refer to RR 3.5). Implied promises can create a performance obligation under a contractual agreement, even when enforcement is not assured because the customer has an expectation of performance by the reporting entity. The boards noted in the basis for conclusions to the revenue standard that failing to account for these implied promises could result in all of the revenue being recognized even when the reporting entity has unsatisfied promises with the customer. Example 12 in the revenue standard (ASC 606-10-55-151 through ASC 606-10-55-157) illustrates a contract containing an implicit promise to provide services.
3.2.3 Promises to stand ready
One type of promise in a contract is a promise to stand ready to provide goods or services in the future (“stand-ready obligations”). Stand-ready obligations generally arise when a reporting entity is obligated to provide an unspecified quantity of a good or service to a customer for a specified period of time. That is, the nature of the promise is to provide the customer with access to goods or services (e.g., when-and-if available or as needed). Arrangements that include a specified quantity of goods and services generally contain a promise to transfer the individual goods or services rather than a promise to stand ready. An example of a stand-ready obligation is a promise to provide an unspecified number of updates or upgrade to a software license on a when-and-if-available basis. In contrast, a promise to provide one or more specified upgrades to a software license is not a stand-ready obligation.
Arrangements that require the customer to make an additional purchasing decision generally do not contain a promise to stand ready. An example is a supply agreement that obligates the reporting entity to deliver products when the customer decides to make a purchase and submits a purchase order. Although the reporting entity is obligated to fulfill the purchase order when it is submitted, the nature of the promise to the customer is to transfer products, not to provide a service of standing ready. Refer to RR 3.5 for further discussion of options to purchase additional goods or services.
Judgment may be required to determine whether a contract includes a stand-ready obligation. Refer to Revenue TRG Memo No. 16 and the related meeting minutes in Revenue TRG Memo No. 25 for further discussion and examples of stand-ready obligations.
As discussed in Question RR 3-2, stand-ready obligations typically meet the criteria to be accounted for as a series of distinct goods or services and therefore, a single performance obligation. Refer to RR 6.4.3 for considerations regarding recognition of revenue for stand-ready obligations.
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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