A series of distinct goods or services is accounted for as a single performance obligation if it meets certain criteria (see further discussion in RR 3
). When a contract includes a series accounted for as a single performance obligation and also includes an element of variable consideration, management should consider the distinct goods or services (rather than the series) for the purpose of allocating variable consideration. In other words, the series is not treated as a single performance obligation for purposes of allocating variable consideration. Management should apply the guidance in ASC 606-10-32-40
(refer to RR 5.5.1
) to determine whether variable consideration should be allocated entirely to a distinct good or service within a series.
Example RR 5-8, Example RR 5-9, and Example RR 5-10 illustrate the allocation of variable consideration in an arrangement that is a series of distinct goods and services. This concept is also illustrated in Example 12A of ASC 606
through ASC 606-10-55-158
EXAMPLE RR 5-8
Allocating variable consideration to a series – performance bonus
Air Inc enters into a three-year contract to provide air conditioning to the operator of an office building using its proprietary geothermal heating and cooling system. Air Inc is entitled to a semiannual performance bonus if the customer’s cost to heat and cool the building is decreased by at least 10% compared to its prior cost. The comparison of current cost to prior cost is made semi-annually, using the average of the most recent six-months compared to the same six-month period in the prior year.
Air Inc accounts for the series of distinct services provided over the three-year contract as a single performance obligation satisfied over time.
Air Inc has not previously used its systems for buildings in this region. Air Inc therefore does not include any variable consideration related to the performance bonus in the transaction price during the first six months of providing service, as it does not believe that it is probable that a significant reversal of cumulative revenue recognized will not occur if its estimate of customer cost savings changes. At the end of the first six months, the customer's costs have decreased by 12% over the prior comparative period and Air Inc becomes entitled to the performance bonus.
How should Air Inc account for the performance bonus?
Air Inc should allocate the performance bonus to the distinct services to which it relates (that is, the related six-month period) if management concludes the results are consistent with the allocation objective. Assuming this is the case, Air Inc would recognize the performance bonus (the change in the estimate of variable consideration) immediately because it relates to distinct services that have already been performed. It would not be appropriate to allocate the change in variable consideration to the entire performance obligation (that is, recognize the amount over the entire three-year contract).
EXAMPLE RR 5-9
Allocating variable consideration to a series – pricing varies based on usage
Transaction Processor (TP) enters into a two-year contract with a customer whereby TP will process all transactions on behalf of the customer. The customer is obligated to use TP’s system to process all of its transactions; however, the ultimate quantity of transactions is unknown. TP charges the customer a monthly fee calculated as $0.03 per transaction processed during the month.
TP concludes that the nature of its promise is a series of distinct monthly processing services and accounts for the two-year contract as a single performance obligation.
How should TP allocate the variable consideration in this arrangement?
TP should allocate the variable monthly fee to the distinct monthly service to which it relates, assuming the results are consistent with the allocation objective. TP would determine that the allocation objective is met because the fees are priced consistently throughout the contract and the rates are consistent with the reporting entity’s pricing practices with similar customers.
Assessing whether the allocation objective is met will require judgment. For example, if the rate per transaction processed was not consistent throughout the contract, TP would have to evaluate the reasons for the varying rates to assess whether the results of allocating each month’s fee to the monthly service are reasonable. TP should consider, among other factors, whether the rates are based on market terms and whether changes in the rate are substantive and linked to changes in value provided to the customer. For example, if the terms were structured to simply recognize more revenue earlier in the contract, this is a circumstance when the allocation objective would not be met. Management should also consider whether arrangements with declining prices include a future discount for which revenue should be deferred. Refer to Revenue TRG Memo No. 39
and the related meeting minutes in Revenue TRG Memo No. 44
for further discussion of this topic.
EXAMPLE RR 5-10
Allocating variable consideration to a series – contract with an upfront fee
CloudCo enters into a contract to provide a customer with a cloud-based solution to process payroll over a one-year period. The customer cannot take possession of the software at any time during the hosting period; therefore, the contract does not include a license. CloudCo charges the customer an upfront fee of $1 million and a monthly fee of $2 for each employee’s payroll processed through the cloud-based solution. If the customer renews the contract, it will have to pay a similar upfront fee.
CloudCo concludes that the nature of its promise is a series of distinct monthly services and accounts for the one-year contract as a single performance obligation.
In the first quarter of the year, the monthly fees for payroll processed in January, February, and March are $50,000, $51,000, and $52,000, respectively.
How should CloudCo recognize revenue from this arrangement?
CloudCo should determine an appropriate measure of progress to recognize the $1 million upfront fee, which would likely be a time-based measure (that is, ratable recognition over the contract term). CloudCo should allocate the variable monthly fees to the distinct monthly service to which they relate (that is, $50,000 to January, $51,000 to February, and $52,000 to March). The allocation objective is met because the $2 monthly fee per employee is consistent throughout the contract and the variable consideration can be allocated to the distinct service to which it relates, which is the monthly payroll processing service in January, February, and March.
The resulting accounting is that the upfront fee is spread ratably, but the variable fee is not. This does not mean that the reporting entity is using multiple measures of progress. The single measure of progress for the contract is a time-based measure, but the variable fee is allocated to specific time periods in accordance with the allocation guidance as described in RR 5.5.1