It is common in some industries for reporting entities to charge customers a fee at or near inception of a contract. These upfront fees are often nonrefundable and could be labeled as fees for set up, access, activation, initiation, joining, or membership.
A reporting entity needs to analyze each arrangement involving upfront fees to determine whether any revenue should be recognized when the fee is received.
Excerpt from ASC 606-10-55-51
To identify performance obligations in such contracts, an entity should assess whether the fee relates to the transfer of a promised good or service. In many cases, even though a nonrefundable upfront fee relates to an activity that the entity is required to undertake at or near contract inception to fulfill the contract, that activity does not result in the transfer of a promised good or service to the customer... Instead, the upfront fee is an advance payment for future goods or services and, therefore, would be recognized as revenue when those future goods or services are provided. The revenue recognition period would extend beyond the initial contractual period if the entity grants the customer the option to renew the contract and that option provides the customer with a material right.
No revenue should be recognized upon receipt of an upfront fee, even if it is nonrefundable, if the fee does not relate to the satisfaction of a performance obligation. Nonrefundable upfront fees are included in the transaction price and allocated to the separate performance obligations in the contract. Revenue is recognized as the performance obligations are satisfied. This concept is illustrated in Example 53 of the revenue standard (ASC 606-10-55-358
through ASC 606-10-55-360
There could be situations, as illustrated in Example RR 8-4, when an upfront fee relates to separate performance obligations satisfied at different points in time.
EXAMPLE RR 8-4
Upfront fee allocated to separate performance obligations
Biotech enters into a contract with Pharma for the license and development of a drug compound. The contract requires Biotech to perform research and development (R&D) services to get the drug compound through regulatory approval. Biotech receives an upfront fee of $50 million, fees for R&D services, and milestone-based payments upon the achievement of specified acts.
Biotech concludes that the arrangement includes two separate performance obligations: (1) license of the intellectual property and (2) R&D services. There are no other performance obligations in the arrangement.
How should Biotech allocate the consideration in the arrangement, including the $50 million upfront fee?
Biotech needs to determine the transaction price at the inception of the contract, which will include both the fixed and variable consideration. The fixed consideration is the upfront fee. The variable consideration includes the fees for R&D services and the milestone-based payments and is estimated based on the principles discussed in RR 4
. Once Biotech determines the total transaction price, it should allocate that amount to the two performance obligations. See RR 5
for further information on allocation of the transaction price to performance obligations.
Reporting entities sometimes perform set-up or mobilization activities at or near contract inception to be able to fulfill the obligations in the contract. These activities could involve system preparation, hiring of additional personnel, or mobilization of assets to where the service will take place. Nonrefundable fees charged at the inception of an arrangement are often intended to compensate the reporting entity for the cost of these activities. Set-up or mobilization efforts might be critical to the contract, but they typically do not satisfy performance obligations, as no good or service is transferred to the customer. The nonrefundable fee, therefore, is an advance payment for the future goods and services to be provided.
Set-up or mobilization costs should be disregarded in the measure of progress for performance obligations satisfied over time if they do not depict the transfer of services to the customer. Some mobilization costs might be capitalized as fulfillment costs, however, if certain criteria are met. See RR 11
for further information on capitalization of contract costs.