A company pays its sales representative a $3,000 commission only if a prospective customer signs the contract. The company also incurs a $1,500 cost preparing a competitive bid proposal for that same prospective customer, a cost it would incur whether or not it wins the contract. Under ASC 340-40-25-1, which cost qualifies as an incremental cost of obtaining a contract that the entity must recognize as an asset (subject to expected recovery)?
- Both costs equally, since both were incurred while pursuing the same prospective customer contract
- Only the $3,000 commission, because it would not have been incurred if the contract had not been obtained, unlike the bid-preparation cost which would be incurred regardless of the outcome
- Only the $1,500 bid-preparation cost, because it was incurred before the commission became payable
- Neither cost, because ASC 340-40 only permits capitalizing costs that are explicitly itemized in the signed contract
Why B? And why not the others?
Correct answer: B. Only the $3,000 commission, because it would not have been incurred if the contract had not been obtained, unlike the bid-preparation cost which would be incurred regardless of the outcome
ASC 340-40-25-1 defines incremental costs of obtaining a contract as costs an entity would not have incurred if the contract had not been obtained; the commission tied solely to signing meets this test and must be recognized as an asset if the entity expects to recover it. The bid-preparation cost fails the incremental test because, under 340-40-25-2, costs that would have been incurred regardless of whether the contract was won are expensed as incurred unless explicitly chargeable to the customer regardless of outcome. Treating both costs the same ignores that only one is conditional on winning the deal. Treating only the bid-preparation cost as capitalizable inverts the rule entirely, since it is precisely the cost that is not contingent on obtaining the contract that must be expensed rather than capitalized. There is also no requirement that a capitalizable cost be separately itemized in the signed contract; the test turns on whether the cost was contingent on winning the contract, not on how or where it is documented.
Source: FASB Accounting Standards Codification: ASC 340-40-25-1 and 25-2, Other Assets and Deferred Costs — Contracts with Customers