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The revenue standard provides the following guidance on customer options.

ASC 606-10-55-42

If, in a contract, an entity grants a customer the option to acquire additional goods or services, that option gives rise to a performance obligation in the contract only if the option provides a material right to the customer that it would not receive without entering into that contract (for example, a discount that is incremental to the range of discounts typically given for those goods or services to that class of customer in that geographical area or market). If the option provides a material right to the customer, the customer in effect pays the entity in advance for future goods or services, and the entity recognizes revenue when those future goods or services are transferred or when the option expires.

An option that provides a customer with free or discounted goods or services in the future might be a material right. A material right is a promise embedded in a current contract that should be accounted for as a separate performance obligation.
An option to purchase additional goods or services at their standalone selling prices is a marketing offer and therefore not a material right. This is true regardless of whether the customer obtained the option only as a result of entering into the current transaction. An option to purchase additional goods or services in the future at a current standalone selling price could be a material right, however, if prices are expected to increase. This is because the customer is being offered a discount on future goods compared to what others will have to pay as a result of entering into the current transaction.
The evaluation of whether an option provides a material right to a customer requires judgment. Both quantitative and qualitative factors should be considered, including whether the right accumulates (for example, loyalty points). Management should consider relevant transactions, including the cumulative value of rights received in the current transaction, rights that have accumulated from past transactions, and additional rights expected from future transactions with the customer. Refer to Revenue TRG Memo No. 6 and the related meeting minutes in Revenue TRG Memo No. 11 for further discussion of accumulating rights.
Management should also consider whether a future discount offered to a customer is incremental to the range of discounts typically given to the same class of customer. Future discounts do not provide a material right if the customer could obtain the same discount without entering into the current transaction. The “class of customer” used in this assessment should include comparable customers (for example, customers in the same geographical location or market) that did not make the same prior purchases. For example, if a retailer offers a 50% discount off of a future purchase to customers that purchase a television, management should assess whether the discount is incremental to discounts provided to customers that did not purchase a television. Refer to US Revenue TRG Memo No. 54 and the related meeting minutes in Revenue TRG Memo No. 55 for further discussion of class of customer. 
Example RR 7-1, Example RR 7-2, and Example RR 7-3 illustrate how to assess whether an option provides a material right. This concept is also illustrated in Examples 49, 50, and 51 of the revenue standard (ASC 606-10-55-336 through ASC 606-10-55-352).
EXAMPLE RR 7-1

Customer options – option that does not provide a material right
Manufacturer enters into an arrangement to provide machinery and 200 hours of consulting services to Retailer for $300,000. The standalone selling price is $275,000 for the machinery and $250 per hour for the consulting services. The machinery and consulting services are distinct and accounted for as separate performance obligations.
Manufacturer also provides Retailer an option to purchase ten additional hours of consulting services at a rate of $225 per hour during the next 14 days, a 10%discount off the standalone selling price. Manufacturer offers a similar 10% discount on consulting services as part of a promotional campaign during the same period.
Does the option to purchase additional consulting services provide a material right to the customer?
Analysis
No, the option does not provide a material right in this example. The discount is not incremental to the discount offered to a similar class of customers because it reflects the standalone selling price of hours offered to similar customers that did not enter into a current transaction to purchase the machinery. The option is a marketing offer that is not part of the current contract. The option would be accounted for when it is exercised by the customer.
EXAMPLE RR 7-2

Customer options – option that does not provide a material right
Telecom enters into a contract to provide unlimited telecom services under a multi-line “family” plan on a monthly basis. The customer has the option to add additional lines to the plan each month for a specified package price that reflects a decrease in the monthly service fee per line as additional lines are added. When customers add or subtract lines from the plan, they are making a decision on a month-to-month basis regarding which family plan to purchase that month (for example, a three-line plan vs. a four-line plan).
Does the option to add an additional line to the plan provide the customer with a material right?
Analysis
No, the option does not provide the customer with a material right. The pricing for the family plan is based on the number of lines purchased that month and is consistent across customers, regardless of the plan a customer purchased in prior months. The customer is not receiving a discount based on its prior purchases.
EXAMPLE RR 7-3

Customer options — option that provides a material right
Retailer has a loyalty program that awards its customers one loyalty point for every $10 spent in Retailer’s store. Program members can exchange their accumulated points for free product sold by Retailer. Based on historical data, customers frequently accumulate enough points to receive free product.
Customer purchases a product from Retailer for $50 and earns five loyalty points. Retailer estimates a standalone selling price of $0.20 per point (a total of $1 for the five points earned) on the basis of the likelihood of redemption.
Do the loyalty points provide a material right?
Analysis
Yes, the loyalty points provide a material right. Although the five points earned in this transaction might not be individually material, the points accumulate and provide the customer the right to a free product. A portion of the revenue from the transaction should be allocated to the loyalty points and recognized when the points are redeemed or expire.

7.2.1 Determining the standalone selling price of customer options

Management needs to determine the standalone selling price of an option that is a material right in order to allocate a portion of the transaction price to it. Refer to RR 5 for discussion of allocating the transaction price.
The observable standalone selling price of the option should be used, if available. The standalone selling price of the option should be estimated if it is not directly observable, which is often the case. For example, management might estimate the standalone selling price of customer loyalty points as the average standalone selling price of the underlying goods or services purchased with the points.
The revenue standard provides the following guidance on estimating the standalone selling price of an option that provides a material right.

Excerpt from ASC 606-10-55-44

If the standalone selling price for a customer's option to acquire additional goods or services is not directly observable, an entity should estimate it. That estimate should reflect the discount that the customer would obtain when exercising the option, adjusted for both of the following:
a. Any discount that the customer could receive without exercising the option
b. The likelihood that the option will be exercised.

Adjusting for discounts available to any other customer ensures that the standalone selling price reflects only the incremental value the customer has received as a result of the current purchase.
The standalone selling price of the options should also reflect only those options that are expected to be redeemed. In other words, the estimated standalone selling price is reduced for expected “breakage.” Breakage is the extent to which future performance is not expected to be required because the customer does not redeem the option (refer to RR 7.4). The transaction price is therefore only allocated to obligations that are expected to be satisfied.
Management should consider the factors discussed in RR 4.3.2 (variable consideration), as well as the reporting entity's history and the history of others with similar arrangements, when assessing its ability to estimate the number of options that will not be exercised. A reporting entity should recognize a reduction for breakage only if it is probable that doing so will not result in a subsequent significant reversal of cumulative revenue recognized. Refer to RR 4 for further discussion of the constraint on variable consideration.
Judgment is needed to estimate the standalone selling price of options in many cases, as no one method is prescribed. Management may use option-pricing models to estimate the standalone selling price of an option. An option's price should include its intrinsic value, which is the value of the option if it were exercised today. Option-pricing models typically include time value, but the revenue standard does not require reporting entities to include time value in the estimate of the standalone selling price of the option.
Certain options, such as customer loyalty points, are not typically sold on a standalone basis. Management should consider whether the price charged when loyalty points are sold separately is reflective of the standalone selling price in an arrangement with multiple goods or services.

Example RR 7-4 illustrates how to account for an option that provides a material right.
EXAMPLE RR 7-4

Customer options – option that provides a material right
Retailer sells goods to customers for a contract price of $1,000. Retailer also provides customers a coupon for a 60% discount off of a future purchase during the next 90 days as part of the transaction. Retailer intends to offer a 10% discount to all other customers as part of a promotional campaign during the same period. Retailer estimates that 75% of customers that receive the coupon will exercise the option for the purchase of, on average, $400 of discounted additional product.

How should Retailer account for the option provided by the coupon?
Analysis
Retailer should account for the option as a separate performance obligation, as it provides a material right. The discount is incremental to the 10% discount offered to a similar class of customers during the period. The customers are in effect paying Retailer in advance for future goods or services. The standalone selling price of the option is $150, calculated as the estimated average purchase price of additional products ($400) multiplied by the incremental discount (50%), multiplied by the likelihood of exercise (75%). The transaction price allocated to the discount, based on its relative standalone selling price, will be recognized upon exercise of the coupon (that is, upon purchase of the additional product) or expiry.

7.2.2 Accounting for the exercise of a customer option

When a customer exercises an option, the customer pays the remaining consideration (if any) for the good or service underlying the option. There are two supportable approaches to account for the exercise of an option:
  • Account for the exercise of the option as a contract modification. Refer to RR 2.9 for further discussion on contract modifications.
  • Account for the exercise of the option as a continuation of the contract. Any additional consideration is allocated to the goods or services underlying the material right and revenue is recognized when control transfers.
Similar transactions should be accounted for in the same manner. The financial reporting outcome of applying either method will be the same in many fact patterns. Refer to Revenue TRG Memo No. 32 and the related meeting minutes in Revenue TRG Memo No. 34 for further discussion of this topic.Example RR 7-5 illustrates the two approaches to account for the exercise of a customer option.
EXAMPLE RR 7-5

Customer options – exercise of an option
ServeCo enters into a contract with Customer to provide two years of Service A for $200. The arrangement also includes an option for Customer to purchase one year of Service B for $100. The standalone selling prices of Services A and B are $200 and $160, respectively. ServeCo concludes that the option to purchase Service B at a discount provides Customer with a material right. ServeCo’s estimate of the standalone selling price of the option is $50, which incorporates the likelihood that Customer will exercise the option.
ServeCo allocates the $200 transaction price to each performance obligation as follows:
Service A (($200 / $250) x $200)
$160
Option to purchase Service B (($50 / $250) x $200)
$40
ServeCo recognizes the revenue allocated to Service A over the two-year service period. The revenue allocated to the option to purchase Service B is deferred until Service B is transferred to Customer or the option expires.
Three months after entering into the contract, Customer elects to exercise its option to purchase Service B for $100. Service B is a distinct service (that is, Service B would not be combined with Service A into a single performance obligation).
How should ServeCo account for the exercise of the option to purchase Service B?
Analysis
ServeCo can account for Customer’s exercise of its option as a continuation of the contract or as a contract modification. Under the first approach, ServeCo would allocate the additional $100 paid by Customer upon exercise of the option to Service B and recognize a total of $140 ($100 plus $40 originally allocated to the option) over the period Service B is transferred to Customer.
Under the second approach, ServeCo would account for Service B by applying the contract modification guidance. This would require assessing whether the additional consideration reflects the standalone selling price of the additional goods or services. Refer to RR 2.9 for guidance on applying the contract modification guidance.

7.2.3 Volume discounts

Volume discounts are often offered to customers as an incentive to encourage additional purchases and customer loyalty. Some volume discounts apply retroactively once the customer completes a specified volume of purchases. Other volume discounts only apply prospectively to future purchases that are optional.

Discounts that are retroactive should be accounted for as variable consideration because the transaction price is uncertain until the customer completes (or fails to complete) the specified volume of purchases. Refer to RR 4.3.3.3 for discussion of retroactive volume discounts. Discounts that apply only to future, optional purchases should be assessed to determine if they provide a material right. Both prospective and retrospective volume discounts will typically result in deferral of revenue if the customer is expected to make future purchases.
Volume discounts take various forms and management may need to apply judgment to determine whether discounted pricing for optional future purchases provides a material right. Example RR 7-6 illustrates the accounting for a prospective volume discount.
EXAMPLE RR 7-6

Volume discount — pricing of optional purchases provides a material right
Manufacturer enters into a three-year contract with Customer to deliver high performance plastics. The contract stipulates that the price per container will decrease as sales volume increases during the calendar year as follows:
Price per container
Sales volume
$100
0–1,000,000 containers
$90
1,000,001–3,000,000 containers
$85
3,000,001 containers or more
View table
Management believes that total sales volume for the year will be 2.5 million containers based on its experience with similar contracts and forecasted sales to Customer; however, Customer is not committed to purchase any minimum volume of containers. Assume that management has concluded that the volume discount provides a material right to Customer.
How should Manufacturer account for the prospective volume discount?
Analysis
Manufacturer should account for the prospective volume discount as a separate performance obligation in the form of a material right (option to purchase additional products at a discount) and allocate the transaction price to the goods (high performance plastics) and the option based on their relative standalone selling prices.
Assuming Manufacturer elects to apply the practical alternative in ASC 606-10-55-45 (because the discounted goods to be purchased in the future are the same as the initial goods being purchased (refer to RR 7.3)), it would allocate the transaction price based on the consideration for those additional goods as follows:
1,000,000 containers @ $100 each
$100,000,000
1,500,000 containers @ $90 each
$135,000,000
Total expected consideration
$235,000,000
Total expected volume of containers
2,500,000
Transaction price allocated per container ($235,000,000/2,500,000)
$94
Transaction price allocated to material right on first 1,000,000 containers ($100 - $94)
$6
View table
Manufacturer would therefore recognize revenue of $94 for each of the first 1,000,000 containers, with $6 ($100 price paid by customer in excess of the $94 transaction price allocated to a container) deferred as a contract liability for the material right not yet satisfied. The contract liability would accumulate until the discounted containers (those purchased by the customer for $90) are delivered, at which time it would be recognized as revenue as the containers are delivered.
Manufacturer would update its estimate of the total sales volume at each reporting date with a corresponding adjustment to cumulative revenue and the value of the contract liability.

7.2.4 Significant financing component considerations

Options to acquire additional goods and services are often outstanding for periods extending beyond one year (for example, point and loyalty programs). Management is not required to consider whether there is a significant financing component associated with options to acquire additional goods or services if the timing of redemption is at the discretion of the customer. However, an option could include a significant financing component if the timing of redemption is not at the discretion of the customer (for example, if the option can only be exercised on a defined date(s) one year or more after the date cash is received). Refer to RR 4.4 for further discussion of significant financing components. Refer also to Revenue TRG Memo No. 32 and the related meeting minutes in Revenue TRG Memo No. 34 for further discussion of this topic.

7.2.5 Customer loyalty programs

Customer loyalty programs are used to build brand loyalty and increase sales volume. Examples of customer loyalty programs are varied and include airlines that offer “free” air miles and retail stores that provide future discounts after a specified number of purchases. The incentives may go by different names (for example, points, rewards, air miles, or stamps), but they all represent discounts that the customer can choose to use in the future to acquire additional goods or services. Obligations related to customer loyalty programs can be significant even where the value of each individual incentive is insignificant, as illustrated in Example RR 7-3 above.
A portion of the transaction price should be allocated to the material right (that is, the points). The amount allocated is based on the relative standalone selling price of the points determined in accordance with the guidance outlined in RR 7.2.1, not the cost of fulfilling awards earned. Revenue is recognized when the reporting entity has satisfied its performance obligation relating to the points or when the points expire. This concept is illustrated in Example 52 of the revenue standard (ASC 606-10-55-353 through ASC 606-10-55-356).
Some arrangements allow a customer to earn points that the customer can choose to redeem in a variety of ways. For example, a customer that earns points from purchases may be able to redeem those points to acquire free or discounted goods or services, or use them to offset outstanding amounts owed to the seller. Refer to RR 7.2.6 for accounting considerations when a customer is offered cash as an incentive. The accounting for these arrangements can be complex.
Customer loyalty programs typically fall into one of three types:
  • Points earned from the purchase of goods or services can only be redeemed for goods and services provided by the issuing reporting  entity.
  • Points earned from the purchase of goods or services can be used to acquire goods or services from other reporting entities, but cannot be redeemed for goods or services sold by the issuing reporting entity.
  • Points earned from the purchase of goods or services can be redeemed either with the issuing reporting entity or with other reporting entities
Management needs to consider the nature of its performance obligation in each of these situations to determine the accounting for the loyalty program.

7.2.5.1 Points redeemed solely by issuer

A reporting entity that operates a program where points can only be redeemed with the reporting entity, recognizes revenue when the customer redeems the points or the points expire (refer to further discussion of accounting for breakage at RR 7.4). The reporting entity is typically the principal for both the sale of the goods or services and satisfying the performance obligation relating to the loyalty points in this situation.
Example RR 7-7 illustrates the accounting when a customer redeems points solely with the issuer of the points.
EXAMPLE RR 7-7

Customer options — loyalty points redeemable solely by issuer
Airline A has a frequent flyer program that rewards customers with frequent flyer miles based on amounts paid for flights. A customer purchases a ticket for $500 (the standalone selling price) and earns 2,500 miles based on the price of the ticket. Miles are redeemable at a rate of 50 miles for $1 ($0.02 per mile). The miles may only be redeemed for flights with Airline A.
Ignoring breakage, how should the consideration be allocated between the miles (accumulating material right) and the flight?
Analysis
The transaction price of $500 should be allocated between the flight and miles based on the relative standalone selling prices of $500 for the flight and $50 (2,500 points x $0.02) for the miles as follows:
Performance Obligation
Standalone Selling Price
%
Allocated Transaction Price
Flight
$500
91%
$455
Miles
$50
9%
$45
$550
Airline A would recognize revenue of $455 when the flight occurs. It would defer revenue of $45 and recognize it upon redemption or expiration of the miles.

7.2.5.2 Points redeemed solely by others

A reporting entity that operates a program in which points can only be redeemed with a third party needs to first consider whether it is the principal or an agent in the arrangement as it relates to the customer loyalty points redeemed by others. Depending on the reporting entity’s conclusions regarding its principal versus agent assessment, the reporting entity would determine the appropriate timing of revenue recognition. The reporting entity should recognize revenue for the net fee or commission retained in the exchange if it is an agent in the arrangement. Refer to RR 10 for further discussion of principal and agent considerations.
The reporting entity recognizes revenue when it satisfies its performance obligation relating to the points and recognizes a liability for the amount the reporting entity expects to pay to the party that will redeem the points. The boards noted in the basis for conclusions to the revenue standard that in instances where the reporting entity is the agent, the reporting entity might satisfy its performance obligation when the points are transferred to the customer, as opposed to when the customer redeems the points with the third party.
Example RR 7-8 illustrates the accounting where a customer is able to redeem points solely with others.
EXAMPLE RR 7-8

Customer options – loyalty points redeemable by another party
Retailer participates in a customer loyalty program in partnership with Airline that awards one air travel point for each dollar a customer spends on goods purchased from Retailer. Program members can only redeem the points for air travel with Airline. The transaction price allocated to each point based on its relative estimated standalone selling price is $.01. Retailer pays Airline $.009 for each point redeemed.
Retailer sells goods totaling $1 million and grants one million points during the period. Retailer allocates $10,000 of the transaction price to the points, calculated as the number of points issued (one million) multiplied by the allocated transaction price per point ($0.01).
Retailer concludes that its performance obligation is to arrange for the loyalty points to be provided by Airline to the customer and that it is an agent in this transaction in accordance with the guidance in the revenue standard (refer to RR 10).
How should Retailer account for points issued to its customers?
Analysis
Retailer would measure its revenue as the commission it retains for each point redeemed because it concluded that it is an agent in the transaction. The commission is $1,000, which is the difference between the transaction price allocated to the points ($10,000) and the $9,000 paid to Airline. Retailer would recognize its commission when it transfers the points to the customer (upon purchase of goods from Retailer) because Retailer has satisfied its promise to arrange for the loyalty points to be provided by Airline to the customer.

7.2.5.3 Points redeemed by issuer or other third parties

Management needs to consider the nature of the reporting entity's performance obligation if it issues points that can be redeemed either with the issuing reporting entity or with other reporting entities. The issuing reporting entity satisfies its performance obligation relating to the points when it transfers the goods or services to the customer, it transfers the obligation to a third party (and the reporting entity therefore no longer has a stand-ready obligation), or the points expire.
Management will need to assess whether the reporting entity is the principal or an agent in the arrangement if the customer subsequently chooses to redeem the points for goods or services from another party. The reporting entity should recognize revenue for the net fee or commission retained in the exchange if it is an agent in the arrangement. Refer to RR 10 for further discussion of principal and agent considerations.
Example RR 7-9 illustrates the accounting when a customer is able to redeem points with multiple parties.
EXAMPLE RR 7-9

Customer options – loyalty points redeemable by multiple parties
Retailer offers a customer loyalty program in partnership with Hotel whereby Retailer awards one customer loyalty point for each dollar a customer spends on goods purchased from Retailer. Program members can redeem the points for accommodation with Hotel or discounts on future purchases with Retailer. The transaction price allocated to each point based on its relative estimated standalone selling price is $.01.
Retailer sells goods totaling $1 million and grants one million points during the period. Retailer allocates $10,000 of the transaction price to the points, calculated as the number of points issued (one million) multiplied by the allocated transaction price per point ($0.01). Retailer concludes that it has not satisfied its performance obligation as it must stand ready to transfer goods or services if the customer elects not to redeem points with Hotel.
How should Retailer account for points issued to its customers?
Analysis
Retailer should not recognize revenue for the $10,000 allocated to the points when they are issued as it has not satisfied its performance obligation. Retailer should recognize revenue upon redemption of the points by the customer with Retailer, when the obligation is transferred to Hotel, or when the points expire. Retailer will need to assess whether it is the principal or an agent in the arrangement if the customer elects to redeem the points with Hotel.

7.2.6 Noncash and cash incentives

Incentives can include a "free" product or service, such as a free airline ticket provided to a customer upon reaching a specified level of purchases. Management needs to consider whether it is providing more than one promise in the arrangement and therefore needs to account for the “noncash” incentive as a separate performance obligation similar to the accounting for customer loyalty points. Management should also consider whether it is the principal or an agent in the transaction if it concludes that the incentive is a separate performance obligation and it is fulfilled by another party.

Cash incentives, on the other hand, are not performance obligations, but are instead accounted for as a reduction of the transaction price. Refer to RR 4 for discussion of determining transaction price. It may require judgment in certain situations to determine whether an incentive is “cash” or “noncash.” An incentive that is, in substance, a cash payment to the customer is a reduction of the transaction price, and is not a promise of future products or services. Management also needs to consider whether items such as gift certificates or gift cards that can be broadly used in the same manner as cash are in-substance cash payments.

7.2.7 Incentives offered or modified after inception

A reporting entity may offer a certain type of incentive when items are originally offered for sale, but then decide to provide a different or additional incentive on that item if it is not sold in an expected timeframe. This is particularly common where reporting entities sell their goods through distributors to end customers and sales to end customers are not meeting expectations. This can occur even after revenue has been recorded for the initial sale to the distributor.
Management needs to consider whether a change to incentives or an additional incentive is a contract modification. A change to an incentive that provides cash (or additional cash) back to a customer (or a customer’s customer) is a contract modification that affects the measurement of the transaction price. Refer to RR 2.9 for discussion on accounting for contract modifications.
Additional goods or services offered after the initial contract is completed and without additional consideration might not be performance obligations if those promises did not exist at contract inception (explicitly or implicitly based on the reporting entity's customary business practice). Example 12, Case C, of the revenue standard (ASC 606-10-55-156 through ASC 606-10-55-157A) illustrates this fact pattern. Management should consider in this scenario whether it has established a business practice of providing the free good or service when evaluating whether there is an implied promise in future contracts.
Example RR 7-10 illustrates the accounting for a change in incentive offered by a vendor.
EXAMPLE RR 7-10

Customer options – change in incentives offered to customer
Electronics Co sells televisions to Retailer. Electronics Co provides Retailer a free Blu-ray player to be given to customers that purchase the television to help stimulate sales. Retailer then sells the televisions with the free Blu-ray player to end customers. Control transfers and revenue is recognized when the televisions and Blu-ray players are delivered to Retailer.
Electronics Co subsequently adds a $200 rebate to the end customer to assist Retailer with selling the televisions in its inventory in the weeks leading up to a popular sporting event. The promotion applies to all televisions sold during the week prior to the event. Electronics Co has not offered a customer rebate previously and had no expectation of doing so when the televisions were sold to Retailer.
How should Electronics Co account for the offer of the additional $200 rebate?
Analysis
The offer of the additional customer rebate is a contract modification that affects only the transaction price. Electronics Co should account for the $200 rebate as a reduction to the transaction price for the televisions held in stock by Retailer that are expected to be sold during the rebate period, considering the guidance on contract modifications as discussed in RR 2.9.4 and variable consideration as discussed in RR 4.3.
Electronics Co will need to consider whether it plans to offer similar rebates in future transactions (or that the customer will expect such rebates to be offered) and whether those rebates impact the transaction price at the time of initial sale.
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