If a contract meets the five-step criteria at assessment, an entity will not reassess the existence of a contract unless there is a significant change in the facts. At times, contracts may be modified for changes in scope, price, or both. A contract modification exists when the parties to a contract approve a modification that either creates new or changes existing enforceable rights and obligations of the parties involved in the contract. For example, a customer’s financial capabilities may deteriorate to the point that further collectability ceases to be probable and therefore the entity may need to reassess whether a contract for future goods or services continue to exist.
When a contract with a customer does not meet the five criteria and an entity receives consideration from the customer, the entity should recognize the consideration received as revenue only when one or more of the following events have occurred:
The entity has no remaining obligations to transfer goods or services to the customer, and all, or substantially all, of the consideration promised by the customer has been received by the entity and is non-refundable.
The contract has been terminated, and the consideration received from the customer is non- refundable.
The entity has transferred control of the goods or services to which the consideration that has been received relates, the entity has stopped transferring goods or services to the customer (if applicable) and has no obligation under the contract to transfer additional goods or services, and the consideration received from the customer is non-refundable.
An entity should recognize the consideration received from a customer as a liability until one of the above events occurs or until the five criteria are subsequently met. Depending on the facts and circumstances relating to the contract, the liability recognized represents the entity’s obligation to either transfer goods or services in the future or refund the consideration received. In either case, the liability should be measured at the amount of consideration received from the customer.
Longo Technologies licenses a patent to Sutra Inc., its customer, in exchange for a usagebased royalty. At the contract inception, the contract meets all the collectability criteria and Longo Technologies accounts for the contract with the Sutra Inc. in accordance with FASB ASC 606. Longo Technologies recognizes revenue when Sutra Inc.’s subsequent usage of the licensed patent occurs.
Facts
First year of the contract
Sutra Inc. provides quarterly reports of usage and pays within the agreed-upon period.
Second year of the contract
Sutra Inc. continues to use Longo Technologies’ patent, but its financial condition declines.
Sutra Inc.’s current access to credit and available cash on hand are limited.
Longo Technologies continues to recognize revenue on the basis of Sutra Inc.’s usage throughout the second year.
Sutra Inc. pays the first quarter’s royalties but makes nominal payments for the usage of the patent in quarters 2, 3, and 4.
Longo Technologies accounts for any impairment of the existing receivable and any credit losses on existing contract balances in accordance with other appropriate FASB ASC topics.
Third year of the contract
Sutra Inc. continues to use Longo Technologies’ patent.
Longo Technologies learns that Sutra Inc. has lost access to credit and its major customers and thus the customer’s ability to pay significantly deteriorates.
Longo Technologies concludes that it is unlikely that Sutra Inc. will be able to make any further royalty payments for ongoing usage of the patent.
As a result of the significant change in facts and circumstances, Longo Technologies reassesses whether collectability is probable and determines that the criteria has not been met because it is no longer probable that they will collect the consideration to which they will be entitled.
Longo Technologies ceases to recognize any further revenue associated with Sutra Inc.’s future usage of its patent.
Longo Technologies accounts for any impairment and additional credit loss on the existing receivable in accordance with other appropriate FASB ASC topics.
Conclusion
In year three when Longo Technologies learned that Sutra Inc. had lost access to credit and its major customers thereby significantly impacting their ability to pay the royalties, they reassessed that the collectability was no longer probable and ceased recognizing any future revenue associated with Sutra Inc.’s usage of its patent.
Knowledge check
1 When a contract with a customer does not meet the five criteria and an entity receives consideration from the customer, the entity should recognize the consideration received as revenue only when:The entity has no remaining obligations to transfer goods or services to the customer, and all, or substantially all, of the consideration promised by the customer has been received by the entity and is non-refundable.The contract has been terminated, and the consideration received from the customer is refundable.The entity maintains control of the goods or services to which the consideration that has been received.The entity continues to transfer goods or services to the customer and the consideration received from the customer is non-refundable.
Combining contracts
An entity should combine two or more contracts if the contracts were entered into at or near the same time with the same customer or related parties of the customer, if at least one of the following applies:
The contracts are negotiated as a package with a single commercial objective.
The amount of consideration in one contract depends on the price or performance of the other contract.
The goods or services are a single performance obligation.
Although not all inclusive, the following are some examples of when an entity should possibly consider combining separate contract with the same customer, keeping in mind that judgment is required because additional facts or different circumstances could result in a different conclusion.
Entities that provide engineering and construction services in separate contracts with the same customer, whose contracts are issued at or near the same time, may need to combine these separate contracts if the two contracts are for the design and building of a single capital asset and would be deemed a single performance obligation had they been in a single contract; therefore, these contracts should likely should be combined.
Educational institutions will need to determine if tuition and housing (or any other contracts entered into with the student) are contracted together in a single contract or in separate contracts. If entered into at or near the same time with the same student, specifically, if the contracts are negotiated as a package with a single commercial objective, the amount of consideration to be paid in one contract depends on the price or performance of the other contract, or if the services promised in the contracts are a single performance obligation, then the educational institution would combine the contracts. When making the determination of whether to combine contracts for tuition and housing, the educational institution would need to consider whether a discount (for example, financial aid) has been provided in a bundled arrangement. If the single commercial objective criterion has not been met, then the educational institution would