ASC 606 Contract Modification Examples: What You Need to Know
The Financial Accounting Standards Board (FASB) developed the Accounting Standards Codification (ASC) 606, which sets out the requirements for recognizing revenue from customer contracts. One key aspect of ASC 606 is contract modifications, which can occur when changes are made to an existing contract between a company and its customer.
In this article, we’ll explore ASC 606 contract modification examples and how they can affect a company’s revenue recognition.
What is a Contract Modification?
A contract modification is a change made to an existing contract that alters its original terms and conditions. These changes can come in various forms, such as:
– Changes in the pricing or payment terms
– Adjustments to the scope of the product or service
– Extensions or reductions in the delivery timeline
– Alterations in the warranties or guarantees
When a contract is modified, the original agreement is updated to reflect the changes, and the updated agreement becomes the new contract. In the context of ASC 606, a contract modification can impact the timing and amount of revenue recognition.
How Does ASC 606 Treat Contract Modifications?
Under ASC 606, a contract modification can be accounted for in one of two ways, depending on the nature of the change:
1. A Modification that Increases the Transaction Price
If a contract modification results in an increase in the transaction price, the additional revenue should be recognized as follows:
– Allocate the additional transaction price to the remaining performance obligations based on their relative standalone selling prices.
– Recognize the additional revenue as soon as the company satisfies the remaining performance obligations.
For example, if a customer buys a subscription for a one-year term at $100 per month, and then decides to extend the term for another six months at $110 per month, the additional $660 in revenue from the extension should be allocated to the remaining months of the subscription and recognized as revenue over the extension period.
2. A Modification that Does Not Increase the Transaction Price
If a contract modification does not increase the transaction price, a company should evaluate whether the change represents a separate contract or a modification of the original contract. This determination should be based on whether the additional goods or services are distinct from those in the original contract.
For example, if a customer buys a computer with a three-year warranty, and then decides to add a second computer to the contract without increasing the price or warranty length, the second computer would likely be considered a separate contract. The revenue from the second computer would be recognized according to the company’s revenue recognition policies for new contracts.
Conclusion
ASC 606 contract modifications can have a significant impact on a company’s revenue recognition, especially when it comes to changes in transaction price. By carefully assessing and accounting for contract modifications, companies can ensure they are accurately recognizing revenue in accordance with ASC 606. If you need assistance with navigating ASC 606 and contract modifications, it’s always a good idea to consult with a qualified accountant or auditor.