SmokeyMan LO: Virtual Goods Case Study

Published Date:
Aug 5, 2020
Updated Date:

In today’s virtual gaming world, many games across multiple platforms allow players to access their virtual environment for free while in-game purchases of various virtual currencies and goods allow players to enhance gameplay. Popular freemium games such as Candy Crush, Clash of Clans, and Pokémon GO have been successful. The following case based on SmokeyMan LO, a hypothetical app-based game, analyzes revenue recognition under Accounting Standards Codification (ASC) 606, Revenue from Contracts with Customers, for freemium-type games with virtual currency and goods.


SmokeyMan LO is a popular app-based freemium game created by Antics, Inc (“Antics”). The game allows players to fight virtual fires in a form of “augmented reality” where players interact with their surroundings using their phones. Players can benefit from the game without spending money. However, SmokeyMan LO offers in-app purchases intended to enhance the players’ experience.

Paying players first purchase SmokeyCoins, the in-game currency. SmokeyCoins can be purchased in pre-set increments, including 100 SmokeyCoins for $0.99, 550 SmokeyCoins for $4.99, etc. After purchasing SmokeyCoins, players may exchange the virtual currency for certain game enhancements called virtual goods. Virtual goods may have a determinable life (“consumable goods”) or may be available indefinitely (“durable goods”).  Below are examples of both consumable goods and durable goods available on SmokeyMan LO.

Consumable Goods Durable Goods
Fire extinguishers Protective Clothing
Water Packs Backpack Storage Space
Oxygen Tanks Fire Axe

SmokeyMan LO does not allow trading of virtual currency or virtual goods among players in the game.

Assume that Antics uses the portfolio method for recognizing revenue due to the large volume of contracts with similar characteristics. To apply the portfolio method, Antics groups classes of contracts based on player characteristics determined by historical data regarding usage patterns.  For this case, we assume SmokeyMan LO’s daily contracts are grouped by class and revenue is recognized separately for each class. Antics’ ability to analyze and group customers appropriately is dependent on the sophistication of its systems and historical data. In this case, we assume Antics has sufficient systems and historical data to make reasonable and appropriate estimates.

On July 5, 2020 Antics processed about 10,000 purchase transactions in SmokeyMan LO for about 7,300,000 SmokeyCoins, totaling $60,400. Antics concludes that these purchases include three classes of players: (1) casual, (2) moderate, and (3) heavy. Antics has determined that players within each class share similar player life (i.e., the total number of days a player uses the game) and gaming behaviors (i.e., the types of virtual goods selected when exchanging SmokeyCoins). Moderate users represent about 30% of today’s volume. Therefore, Antics concludes that moderate users purchased about 2,100,000 SmokeyCoins, totaling $18,120.

The following analysis will be performed using the portfolio method for the moderate user class.

1. Identify the Contract with a Customer

Identifying the contract is relatively straightforward because players agree to the terms of an agreement when purchasing SmokeyCoins. Further, both buyer and seller are substantially committed to the contract and collectability is assured because payment is processed through the app via credit or debit card at the time of purchase.

2. Identify the Performance Obligations in the Contract

In accordance with ASC 606-10-25-14 through 25-22, Antics must assess the goods or services promised to moderate players to identify the performance obligations in the contract. This assessment includes considering explicit and implicit promises made to customers. Often, contracts include more than one promise, and ASC 606 requires that promised goods or services be analyzed to determine distinct performance obligations. For goods or services to be considered distinct, they must be (a) capable of being distinct and (b) separately identifiable. This separability analysis results in a list of all the performance obligations, forming the basis of revenue recognition under ASC 606.

In this case, Antics identifies a promise to display a certain number (about 2,100,000) of SmokeyCoins purchased on July 5, 2020 by users within the game. Contracts in the freemium gaming industry commonly include language dismissing any obligation to continue hosting games or the virtual items purchased by players. However, such language is ignored under ASC 606 because Antics makes an implied promise to continue displaying SmokeyCoins for use in the game by its customary business practices. Therefore, the promise Antics makes with purchasers is to display (a) SmokeyCoins and (b) subsequently traded-for virtual goods, whenever players access SmokeyMan LO through the mobile app.

This promise is similar to the promise described in ASC 606-10-25-18e: providing a service of standing ready to make the services available at the customer’s discretion. Antics must maintain its servers to display SmokeyCoins (and virtual goods subsequently received in exchange for these purchased SmokeyCoins) when the players access the game. The nature of this promise does not change over the service period. Additionally, players simultaneously receive and consume the benefit from Antics’ performance; the service of standing ready is provided evenly over the service period (see section fivebelow for further analysis). This stand-ready obligation meets the criteria in ASC 606-10-25-14b and 25-15 to be considered a series of distinct services. In this case, each time increment (e.g., day or month) can be considered a distinct service period. Antic will use a daily service period.

Antic’s contract with moderate players contains no other implied or explicit promises. Therefore, the singular performance obligation identified in the contract is a stand ready obligation to display virtual coins and subsequently traded-for virtual goods, as discussed above.

3. Determine the Transaction Price

ASC 606 requires entities to determine the total amount of consideration an entity expects to receive in exchange for the promised goods or services (ASC 606-10-32-2). This consideration may include fixed and variable amounts or financing components. In this case, the transaction price is the amount agreed to during the in-app purchase. The total consideration is fixed and paid at the contract’s inception. The contract includes no variable component and all sales are final. Therefore, the transaction price is $18,120 for the transactions with the moderate class of customers on July 5, 2020.

4. Allocate the Transaction Price to the Performance Obligations in the Contract

Under ASC 606, the transaction price for the contract must be allocated to the performance obligations identified in step 2. This allocation is based on the standalone selling price (SSP) of each performance obligation. Often, the SSP is not observable (i.e., certain contract obligations are not sold outside of a bundle). In these instances, entities must estimate the SSP (please see our article on Standalone Selling Prices).

In this case, the performance obligation is a series of distinct goods and services that are substantially the same. Accordingly, the transaction price can be evenly allocated to the distinct service periods that make up the contract:

Month Revenue Recognized Calculation
July $3,926 $18,120 / 120 days * 26 service days in July (starting July 6th)
August $4,681 $18,120 / 120 days * 31 service days in August
September $4,530 $18,120 / 120 days * 30 services days in September
October $4,681 $18,120 / 120 days * 31 service days in October
November $302 $18,120 / 120 days * 2 service days in November
Total $18,120

Total consideration ($18,120) / Distinct Daily Service Periods (see step 5 below for estimate)

5. Recognize Revenue When (or as) the Entity Satisfies a Performance Obligation

In accordance with ASC 606-10-25-23, Antics will recognize revenue as it satisfies the performance obligation which may occur at a point in time or over time. To make this distinction, Antics assesses the criteria in ASC 606-10-25-27. Transfer of control is determined to occur over time if one or more of the following criteria is met:

  1. The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs…
  2. The entity’s performance creates or enhances an asset…that the customer controls as the asset is created or enhanced…
  3. The entity’s performance does not create an asset with an alternative use to the entity…, and the entity has an enforceable right to payment for performance completed to date…”

Antics determines that criterion A is met because players receive the benefits of Antics hosting the players’ SmokeyCoins (and/or the virtual goods that are received in exchange for purchased SmokeyCoins) in the game as Antics performs hosting activities. That is, players simultaneously receive and consume the benefits while the company performs the service. Therefore, revenue should be recognized over time.

Antics must measure progress toward satisfying the performance obligation identified above (ASC 606-10-25-31). This requires determining (1) the duration of the obligation to stand ready and (2) the correct method of measuring the satisfaction of performance obligations, as follows:

Duration of the Obligations

To determine when Antics has reached “complete satisfaction” of its performance obligations, it must analyze how long its obligation to stand ready exists. This analysis is complicated by Antics’ implied promise of continued game hosting (see step 2) and the lack of specific contract end dates, which is common to many service contracts, like Software-as-a-Service (SaaS) arrangements. Additionally, a player’s game activity significantly affects the possible obligation duration. For example, a player may purchase SmokeyCoins but never use them before becoming inactive or may exchange their SmokeyCoins for a durable virtual good that is expected to be available for the duration of the user’s activity period. On the other hand, a player may purchase SmokeyCoins to exchange for a consumable virtual good only a few weeks after the original transaction. In this latter case, the stand ready obligation is satisfied when the consumable good expires. Although Antics could not predict how the customer will use SmokeyCoins, Antics should begin to recognize revenue on the transaction date because the performance obligation is a stand-ready obligation. Therefore, Antics must make an estimate that appropriately reflects the duration of the stand-ready obligation.

As stated above, the moderate class of users share similar game usage lives and virtual goods exchange patterns. Accordingly, Antics can make an estimate of its stand ready obligation “period” based on the average time a moderate player uses the game before becoming inactive, the average time before exchanging SmokeyCoins into virtual goods, and the average type and duration of those virtual goods, among other possible factors. After performing this analysis, Antics determines the average duration for the moderate class player is about 120 days.

Method of Measurement

Antics must consider an appropriate measurement method that faithfully depicts the satisfaction of performance obligations. SmokeyMan LO users simultaneously receive and consume the benefit or value of Antics’ stand ready obligation, and this value is transferred equally throughout the obligation duration. Accordingly, the time elapsed output method of measurement, included in ASC 606-10-55-17, is most appropriate. As shown in the table above, revenue is allocated evenly to the 120 distinct service periods.

Take-Two Interactive: A Company's Analysis Of A Performance Obligation's Recognized Period

Take Two Interactive Software, Inc. (“TTI”) is a company that has paid games with optional in-game purchases. The company has created fan favorites such as NBA 2k and Grand Theft Auto. TTI creates games for almost every console, including Xbox, Playstation, Nintendo Switch, and personal computer systems. TTI treats the in-game purchases as a separate performance obligation, like Smokeyman LO. TTI chose to recognize the revenues associated with these purchases based on the weighted-average life of the relationship with the purchasers, which is the same method that Antics uses in the Smokeyman LO case. The SEC approached TTI about why its revenue recognition method could span a longer period than the length a player would have used the purchased items. For example, an item purchased halfway through the probable lifetime of the player would be recognized by TTI evenly across a period equal to the total average life of all players, rather than the remaining life of the purchaser. This caused revenue to be recognized long after the player stopped playing.

TTI defended its decision with two lines of reasoning. The first rationale is based on ASC 606-10-25-32, which says that “an entity shall apply [a single] method consistently to similar performance obligations and in similar circumstances.” TTI concluded that, for revenue recognition purposes, the proper accounting treatment is to give all in-game purchases a single equivalent lifetime. The company reasoned that all the purchases are “similar” because they are based on the transaction of in-game currency, and it is impossible to estimate the duration of use for every individual purchase. This procedure allows TTI to use a consistent method instead of forcing the company to recognize some revenue immediately while waiting to recognize other revenue, such as for an unperishable item, which could be recognized over the estimated remaining life of the purchaser.

The second rationale TTI used is the qualitative understanding of ASC 606. TTI pointed out that if it were to assign a different life for each transaction, the result would not be “a consistent measure of progress for each distinct performance obligation sold in new contracts” (Comment Letter November 2019). TTI concluded that to most accurately reflect the transfer of control, the company must use the weighted-average user life applied to in-game purchases. This reasoning was accepted by the SEC the following month.

Alternative View

An alternative view considers providing virtual goods as the performance obligation rather than an obligation to display virtual currency and virtual goods. Under this view, virtual currency is like a store gift card with revenue recognition being deferred until virtual currency is exchanged for virtual goods in the future. We believe this alternative view ignores the true nature of Antics’ stand-ready obligation and the utility of virtual currency because of the “promise to deliver a good or service in which the delivery is within control of the customer” (KPMG 4.2.40). The obligation and service of standing ready is not delayed until a future exchange for virtual goods occurs. Instead,  the stand-ready obligation begins immediately as players expect virtual currency to be available whenever they log in to play SmokeyMan LO. Further, Antics engages in the same activities to display virtual currency as it does to display virtual goods (i.e., maintaining servers, etc.).

Resources Consulted