Example RR 6-2, Example RR 6-3, Example RR 6-4, and Example RR 6-5 illustrate the assessment of alternative use and right to payment. These concepts are also illustrated in Examples 14-17 of the revenue standard (ASC 606-10-55-161
through ASC 606-10-55-182
EXAMPLE RR 6-2
Recognizing revenue – asset with an alternative use
Manufacturer enters into a contract to manufacture an automobile for Car Driver. Car Driver specifies certain options such as color, trim, electronics, etc. Car Driver makes a nonrefundable deposit to secure the automobile, but does not control the work in process. Manufacturer could choose at any time to redirect the automobile to another customer and begin production on another automobile for Car Driver with the same specifications.
How should Manufacturer recognize revenue from this contract?
Manufacturer should recognize revenue at a point in time, when control of the automobile passes to Car Driver. The arrangement does not meet the criteria for a performance obligation satisfied over time. Car Driver does not control the asset during the manufacturing process. Car Driver did specify certain elements of the automobile, but these do not create a practical or contractual restriction on Manufacturer's ability to transfer the car to another customer. Manufacturer is able to redirect the automobile to another customer at little or no additional cost and therefore it has an alternative use to Manufacturer.
Now assume the same facts, except Car Driver has an enforceable right to the first automobile produced by Manufacturer. Manufacturer could practically redirect the automobile to another customer, but would be contractually prohibited from doing so. The asset would not have an alternative use to Manufacturer in this situation. The arrangement would meet the criteria for a performance obligation satisfied over time assuming Manufacturer is entitled to payment for the work it performs as the automobile is built.
EXAMPLE RR 6-3
Recognizing revenue – highly specialized asset without an alternative use
Cruise Builders enters into a contract to manufacture a cruise ship for Cruise Line. The ship is designed and manufactured to Cruise Line's specifications. Cruise Builders could redirect the ship to another customer, but only if Cruise Builders incurs significant cost to reconfigure the ship. Assume the following additional facts:
- Cruise Line does not take physical possession of the ship as it is being built.
- The contract contains one performance obligation as the goods and services to be provided are not distinct.
- Cruise Line is obligated to pay Cruise Builder an amount equal to the costs incurred plus an agreed profit margin if Cruise Line cancels the contract.
How should Cruise Builder recognize revenue from this contract?
Cruise Builder should recognize revenue over time as it builds the ship. The asset is constructed to Cruise Line's specifications and would require substantive rework to be useful to another customer. Cruise Builder cannot sell the ship to another customer without significant cost and therefore, the ship does not have an alternative use. Cruise Builder also has a right to payment for performance completed to date. The criteria are met for a performance obligation satisfied over time.
EXAMPLE RR 6-4
Recognizing revenue – right to payment
Design Inc enters into a contract with EquipCo to deliver the next piece of specialized equipment produced. The contract price is $1 million, which includes a profit margin of 30%. EquipCo can terminate the contract at any time. EquipCo makes a nonrefundable deposit at contract inception to cover the cost of materials that Design Inc will procure to produce the specialized equipment. The contract precludes Design Inc from redirecting the equipment to another customer. EquipCo does not control the equipment as it is produced.
How should Design Inc recognize revenue for this contract?
Design Inc should recognize revenue at a point in time, when control of the equipment transfers to EquipCo. The specialized equipment does not have an alternative use to Design Inc because the contract has substantive terms that preclude it from redirecting the equipment to another customer. Design Inc, however, is only entitled to payment for costs incurred, not for costs plus a reasonable profit margin. The criterion for a performance obligation satisfied over time is not met because Design Inc does not have a right to payment for performance completed to date. This is because the contract price includes a profit, yet Design Inc can only recover costs incurred if EquipCo terminates the contract.
EXAMPLE RR 6-5
Recognizing revenue – no right to payment for standard components
MachineCo enters into a contract to build a large, customized piece of equipment for Manufacturer. Because of the unique customer specifications, MachineCo cannot redeploy the equipment to other customers or otherwise modify the design and functionality of the equipment without incurring a substantial amount of rework.
MachineCo purchases or manufactures various standard components used to construct the equipment. MachineCo is entitled to payment for costs incurred plus a reasonable margin if Manufacturer terminates the contract early. MachineCo is not entitled to payment for standard components until they have been integrated into the customized equipment that will delivered to the customer. This is because MachineCo can use those components in other projects before they are integrated into the customized equipment.
Does MachineCo have an enforceable right to payment for performance completed to date?
MachineCo has an enforceable right to payment for performance completed to date because it will be compensated for costs incurred plus a reasonable margin once the standard components have been integrated into the customized equipment. The revenue standard requires a reporting entity to have a right to payment for performance completed at all times during the contract term. MachineCo’s performance related to the contract occurs once it begins to incorporate the standard components into the customized equipment.
MachineCo has an enforceable right to payment and the equipment does not have an alternative use; therefore, MachineCo should recognize revenue over time as it constructs the equipment. MachineCo would record standard components as inventory prior to integration into the customized equipment.