The new revenue recognition standard (ASC 606) is now applicable for all companies. In consulting with many of my clients, I notice they will often miss the new related guidance on costs to obtain or fulfil a contract with a customer. Incremental costs of obtaining a contract (typically commissions) should be capitalized if the entity expects to recover those costs. The capitalized costs are then amortized consistent with the transfer to the customer of the goods and services to which they relate (essentially matching the revenue with the costs). There is a practical expedient to recognize costs of obtaining a contract as expense when incurred if the amortization period of the asset would otherwise be one year or less.
Costs to fulfil a contract should also be capitalized if the following three criteria are met:
- The costs relate directly to a contract or to an anticipated contract that the entity can specifically identify (for example, costs relating to services to be provided under renewal of an existing contract or costs of designing an asset to be transferred under a specific contract that has not yet been approved).
- The costs generate or enhance resources of the entity that will be used in satisfying (or in continuing to satisfy) performance obligations in the future.
- The costs are expected to be recovered.
If costs incurred in fulfilling a contract are within the scope of another ASC topic like inventory or property and equipment, entities should use the guidance in that other topic. Capitalized fulfillment costs are amortized in the same way as costs to obtain a contract. However, there is no practical expedient for contracts one year or less.
Entities will need to consider contract costs, not just revenue, to ensure they are implementing the ASC 606 correctly.
For more information, please contact Audit Director, Nathan Hartman.