The revenue standard provides the following guidance on customer options.
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?
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?
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?
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.