A vendor is midway through a single performance obligation to build a customized software platform for a customer, recognizing revenue over time using a cost-to-cost measure of progress. The customer requests a change order adding further customization work that is highly interrelated with, and not distinct from, the platform already being built, so the additional work and the platform form part of one combined, partially satisfied performance obligation. Under ASC 606-10-25-13(b), how should the vendor account for this modification?
- As part of the existing, not-yet-completed performance obligation, updating the transaction price and the measure of progress and recognizing the cumulative effect of the change as an adjustment to revenue in the period of the modification
- As a separate new contract solely for the additional customization work, accounted for independently of the original platform contract
- Prospectively, as if the original contract were terminated and a new contract were created only for the remaining goods and services
- Retrospectively, by restating the revenue previously recognized on the original contract using the modified total transaction price
Why A? And why not the others?
Correct answer: A. As part of the existing, not-yet-completed performance obligation, updating the transaction price and the measure of progress and recognizing the cumulative effect of the change as an adjustment to revenue in the period of the modification
ASC 606-10-25-13(b) applies when the remaining goods or services promised in a modification are not distinct from those already transferred and therefore form part of a single, partially satisfied performance obligation; in that situation the modification is accounted for as if it were part of the original contract, meaning the vendor updates the transaction price and its measure of progress and recognizes the cumulative effect of that change as an adjustment to revenue in the period of the modification. Treating the additional work as a wholly separate new contract ignores that the work is not distinct from the platform already being built, which is the specific condition that keeps it inside the existing performance obligation rather than spinning off a separate arrangement. Accounting for the change prospectively, as though the original contract were terminated and replaced with a new one covering only the remaining goods and services, describes the treatment reserved for the different fact pattern in ASC 606-10-25-13(a), where the remaining goods or services are distinct from what has already been transferred, which is not the case here. Restating previously recognized revenue retrospectively is never the correct treatment for a contract modification under ASC 606; the cumulative catch-up approach adjusts current-period revenue for the change in transaction price and progress, it does not reopen or restate revenue already recognized in prior periods.
Source: FASB Accounting Standards Codification: ASC 606-10-25-13(b), Revenue from Contracts with Customers — Contract Modifications