41 -45 of FASB ASC 606-10-55 applies.
The following are some types of promised goods or services that may be included in a contract with a customer; keep in mind that the following is not all inclusive:
Sale of goods produced by an entity (for example, inventory of a manufacturer)
Resale of goods purchased by an entity (for example, merchandise of a retailer)
Resale of rights to goods or services purchased by an entity (for example, a ticket resold by an entity acting as a principal)
Performing a contractually agreed-upon task (or tasks) for a customer
Providing a service of standing ready to provide goods or services (for example, unspecified updates to software that are provided on a when-and-if-available basis) or of making goods or services available for a customer to use as and when the customer decides
Providing a service of arranging for another party to transfer goods or services to a customer (for example, acting as an agent of another party)
Granting rights to goods or services to be provided in the future that a customer can resell or provide to its customer (for example, an entity selling a product to a retailer promises to transfer an additional good or service to an individual who purchases the product from the retailer)
Constructing, manufacturing, or developing an asset on behalf of a customer
Granting licenses
Granting options to purchase additional goods or services (when those options provide a customer with a material right)
The term material right is not defined in FASB ASC 606 but is used quite often throughout the illustrative examples in FASB ASC 606. Understanding whether a customer was promised a material right is important because material rights generally give rise to separate performance obligations. Assessing whether an entity has granted a customer a material right might be a bit confusing. To assist in this assessment, an entity will need to consider whether the customer received a promise to acquire an additional good or service they would not have been entitled to had they not entered into the contract. The following are a few examples, although not all inclusive, that might give rise to a material right:
A customer purchasing a good from an entity and upon completion of the transaction receives a coupon or voucher for a percentage off their next purchase.
A customer who is part of an entity’s customer loyalty program purchases a service from an entity, such as airfare, and a certain amount of loyalty points for future use.
The contract with the customer
Arrow Software Company enters into 100 separate contracts with its customers to provide 1 year of database maintenance services for $1,000 per contract. The terms of the contracts specify that at the end of the year, each customer has the option to renew the maintenance contract for a second year by paying an additional $1,000. Customers who renew for a second year also are granted the option to renew for a third year for $1,000. Arrow Software Company charges significantly higher prices for maintenance services to customers that did not initially sign up for the maintenance services. The annual maintenance service would be $3,000 in year 2 and $5,000 in year 3 for customers that did not initially purchase the renewal service or allowed the service to lapse.
Consideration in determining whether a customer received a material right/separate performance obligation
The customers would not have received the renewal options had they not entered into the contracts with Arrow Software Company.
The price for the database maintenance services would be significantly higher in years 2 and 3 without the initial purchase of the renewal service
Conclusion
Arrow Software Company would conclude that the renewal option in its contracts with customers provides a material right that the customers would not receive without entering into the contracts because the price for maintenance services would be significantly higher had those customers not initially elected to purchase the database maintenance services for years 2 and 3. Therefore, Arrow Software Company would conclude that the promise to provide the renewal option is a separate performance obligation.
Determining whether shipping and handling activities are separate performance obligations
An entity might perform shipping and handling activities related to the promise of a good, so an entity might question whether shipping and handling activities are considered performance obligations. If the shipping and handling activities are performed:
Before the customer obtains control of the good, then they are not a promised service to the customer. Rather, the shipping and handling are activities to fulfill the entity’s promise to transfer the good to the customer.
After the customer obtains control of the good, then the entity may elect to account for the shipping and handling as activities to fulfill the promise to transfer the good, in accordance with paragraph 18b of FASB ASC 606-10-25. The entity would have to make an accounting policy election and the application of the election would have to be consistently applied to similar types of transactions. Therefore, if the accounting policy election is made, an entity would not evaluate whether shipping and handling activities are promised services to its customers. Keep in mind that if revenue is recognized for the related good before the shipping and handling activities occur, the related costs of those shipping and handling activities will need to be accrued.
It is not uncommon for entities to transfer control of a good to a customer prior to that good shipping. This is generally referred to as free on board (FOB) shipping point. Entities are required to assess whether shipping and handling activities associated with these FOB shipping point transactions represent a separate performance obligation to a customer. Keep in mind that control of that good has already transferred to the customer and therefore the shipping and handling activities are not part of the entity’s promise to transfer the good to the customer.
Prior to FASB ASC 606, entities entering into FOB shipping point transactions with customers did not generally assess whether the associated shipping and handling was considered to be a separate deliverable (deliverable is a term used in superseded FASB ASC 605, Revenue Recognition). Given this, some entities may fail to realize that they must make an accounting election to not evaluate whether the shipping and handling are promised services to customers, meaning possible separate performance obligations. Note this election will need to be applied consistently to similar transaction types.
The following is some helpful information for entities electing to account for shipping and handling as activities to fulfill the promise to transfer the good to a customer in accordance with paragraph 18b of FASB ASC 606-10-25:
Disclose the election of this policy in the notes to the financial statements in accordance with FASB ASC 235, Notes to Financial Statements.
Apply the policy consistently to similar transaction types.
Do not lose sight of the fact that if revenue is recognized for the related good before the shipping and handling activities occur, the related costs of those