A software company pays a 6% commission on new one-year contracts and expects, based on strong historical experience, that customers will renew annually for many years. On renewal, the company pays only a 1% commission, well below the 6% paid on the initial contract. Under ASC 340-40-35-1, how should the company determine the amortization period for the initial 6% commission asset?
- Because the renewal commission is not commensurate with the initial commission, the initial commission asset should be amortized over the anticipated period of the customer relationship, including expected renewals, not just the one-year initial term
- Because a renewal commission exists at all, no matter its size, the initial commission must always be amortized over the one-year initial term only
- The company must choose between expensing the initial commission immediately or capitalizing it over exactly one year, since ASC 340-40 does not address renewal commissions
- The company should treat the initial commission and each renewal commission as entirely unrelated costs, amortizing each strictly over its own one-year contract with no consideration of whether renewal commissions are commensurate with the initial one
Why A? And why not the others?
Correct answer: A. Because the renewal commission is not commensurate with the initial commission, the initial commission asset should be amortized over the anticipated period of the customer relationship, including expected renewals, not just the one-year initial term
When a commission paid on contract renewal is not commensurate with the commission paid on obtaining the initial contract, the disparity indicates that part of the economic benefit of the initial commission extends beyond the initial term into the anticipated renewals, so ASC 340-40-35-1 calls for amortizing the initial asset over the longer period that includes those expected renewals rather than just the one-year initial term; a 1% renewal commission against a 6% initial commission is a clear case of non-commensurate rates. The claim that any renewal commission, regardless of size, limits amortization to the initial term gets the test backward, since it is specifically when the renewal commission is commensurate with the initial one that amortization stays limited to the initial term, because in that case the initial commission relates only to the initial contract. There is no binary choice under the guidance between immediate expensing and a rigid one-year period; the standard calls for a facts-and-circumstances judgment about the actual transfer pattern the asset relates to. Treating the initial and renewal commissions as entirely unrelated costs skips the very commensurate-versus-not-commensurate comparison that 35-1 requires before deciding whether the original commission's amortization period should extend beyond the initial contract.
Source: FASB Accounting Standards Codification: ASC 340-40-35-1, Other Assets and Deferred Costs — Contracts with Customers