Before a multi-year facilities-management contract begins, a company incurs setup costs to configure equipment specifically for that customer's site. The costs relate directly to this identified contract, they create a dedicated resource (the configured equipment) that the company will use to satisfy its performance obligations over the life of the contract, and the company expects to recover the costs through the fees charged under the contract. Under ASC 340-40-25-5, how should the company account for these setup costs?
- Recognize an asset for the setup costs, because they relate directly to an identified contract, generate a resource used to satisfy future performance obligations, and are expected to be recovered
- Expense the setup costs immediately, because only costs incurred after a contract begins performance can ever be capitalized under ASC 340-40
- Recognize the setup costs as a reduction of the transaction price allocated to the contract's performance obligations
- Capitalize the setup costs only if the contract is later modified to include additional services
Why A? And why not the others?
Correct answer: A. Recognize an asset for the setup costs, because they relate directly to an identified contract, generate a resource used to satisfy future performance obligations, and are expected to be recovered
ASC 340-40-25-5 permits recognizing an asset for costs to fulfill a contract, when the costs are not within the scope of another Topic, only if all three criteria are met: the costs relate directly to a contract the entity can specifically identify, they generate or enhance resources the entity will use to satisfy future performance obligations, and they are expected to be recovered; this scenario states all three are satisfied, so the costs must be capitalized as a fulfillment-cost asset rather than expensed. The claim that only costs incurred after performance begins can be capitalized has no basis in the guidance, since the criteria say nothing about timing relative to the start of performance, only about the nature of the cost itself. Treating the setup cost as a reduction of transaction price confuses cost accounting with revenue allocation, because the transaction price is the consideration the entity expects to receive, not an amount adjusted downward for the entity's own fulfillment costs. Making capitalization contingent on a future contract modification also has no grounding, since the criteria are evaluated based on the facts of the current contract at the time the costs are incurred.
Source: FASB Accounting Standards Codification: ASC 340-40-25-5, Other Assets and Deferred Costs — Contracts with Customers