A company enters into an arrangement to transfer goods to a customer, but at inception it is not probable that the company will collect substantially all of the consideration to which it will be entitled, so the arrangement does not meet the contract-existence criteria in ASC 606-10-25-1. The customer nonetheless pays the company a nonrefundable deposit, and the company has no remaining obligation to transfer any additional goods or services or to refund any of the consideration received. Under ASC 606-10-25-7, how should the company account for the nonrefundable deposit in this situation?
- Continue applying the full five-step model as though the contract-existence criteria were met, simply because cash was actually received
- Recognize the deposit as a long-term liability that is never derecognized as long as the customer relationship continues
- Recognize the nonrefundable consideration received as revenue, because the company has no remaining obligation to transfer goods or services or to refund any of the consideration, which is one of the specified events under ASC 606-10-25-7 that permits recognizing revenue even though the general criteria in 25-1 are not met
- Reverse and refund the deposit automatically, because ASC 606 prohibits recognizing any consideration received under an arrangement that fails to meet the criteria in 25-1
Why C? And why not the others?
Correct answer: C. Recognize the nonrefundable consideration received as revenue, because the company has no remaining obligation to transfer goods or services or to refund any of the consideration, which is one of the specified events under ASC 606-10-25-7 that permits recognizing revenue even though the general criteria in 25-1 are not met
ASC 606-10-25-7 provides that when an arrangement does not meet the contract-existence criteria in ASC 606-10-25-1, the entity recognizes consideration received from the customer as revenue only when specific events occur, including when the entity has no remaining obligation to transfer goods or services to the customer and all, or substantially all, of the consideration promised has been received and is nonrefundable, or when the contract has been terminated; here, the company has already received a nonrefundable deposit and has no remaining obligation to transfer anything further or to refund the amount, so it falls within that specified exception and may recognize the deposit as revenue despite the general Step 1 criteria not being met. Applying the full five-step model as though the criteria were satisfied ignores that the standard specifically withholds ordinary revenue recognition until the 25-1 criteria are met or one of the narrow 25-7 exceptions applies; receiving cash alone does not substitute for meeting the contract-existence criteria. Treating the deposit as a liability that is never derecognized ignores the guidance in ASC 606-10-25-8, which requires the entity to recognize a liability for consideration received only until one of the events in 25-7 occurs or the criteria in 25-1 are subsequently met, not to hold it as a permanent liability once those conditions are satisfied. There is no requirement in ASC 606 to automatically reverse and refund a nonrefundable deposit simply because the contract-existence criteria are not yet met; the standard instead provides the specific liability-then-revenue mechanism in 25-7 and 25-8 for exactly this situation.
Source: FASB Accounting Standards Codification: ASC 606-10-25-7 and 25-8, Revenue from Contracts with Customers — Contracts That Do Not Meet the Criteria