The ASC 606 (revenue recognition) transition: cost capitalization

While we have been focused on the transformational changes in revenue recognition that Accounting Standards Codification (ASC) 606 has brought about, the standard itself also addresses costs associated with obtaining and fulfilling revenue from contracts with customers. As with revenue recognition itself, the codification has never comprehensively addressed costs in connection with contracts. Often, the guidance has been found within the industry sections, or other disparate sections of the codification. The new standard seeks to comprehensively address the issue.

Contract cost guidance has been added to ASC 606 through changes in specific subtopics.

Incremental costs of obtaining a contract

Briefly stated, incremental costs of obtaining a contract should be recognized as an asset if the entity expects to recover such costs, through execution of the contract. The incremental costs are those identified with obtaining a specific contract which otherwise would not have been incurred. A typical example of such a cost would be a sales commission. However, there could be many others. As long as they directly related to the contract they should be capitalized.

The standard provides a practical expedient, wherein an entity may recognize such costs as incurred, if the amortization period of such asset is less than one year.

Amortization should be provided on the asset in a manner that reflects the transfer of goods or services to the customer. The amortization period should be adjusted if the entity anticipates a significant change in the timing of the transfer. Any such change should be accounted for as a change in estimate, i.e. prospectively.

If an entity determines that the remaining balance of the unamortized costs exceeds the remaining amount of consideration to be received on the contract, less the remaining amount of costs (not yet recognized) to be incurred in fulfilling the contract (the remaining margin), the entity shall recognize an impairment charge in profit or loss.

In determining the remaining amount of consideration, the entity shall consider the guidance related to determining the transaction price, without regard to the constraining estimate of variable consideration guidance, adjusted to reflect the credit risk of the customer.

Any impairment loss to the asset will be measured after the entity has considered impairment losses related to other contract assets measured in accordance with the standard.