Because Accounting Standards Codification (ASC) 606 applies only to transactions that an entity enacts with customers, it is important to understand how “customer” is defined under ASC 606. Transactions that an entity enacts with parties other than customers are outside the scope of ASC 606. Consequently, it is important to understand how ASC 606 defines a customer before endeavoring to apply the new guidance.
ASC 606 defines customers as “parties that contract with an entity to obtain goods or services that are an output of the entity’s ordinary activities in exchange for consideration.” Key points of this definition include: (1) the goods or services must be an output of the entity’s ordinary activities and (2) the transaction must be an exchange. If the counterparty to a transaction does not meet this definition of a customer, the transaction will not be accounted for under ASC 606.
(1) Goods or services must be outputs of ordinary activities
ASC 606 is silent on what constitutes the ordinary activities of an entity, but the Financial Accounting Standards Board’s (FASB) Financial Accounting Concepts No. 6 (Con 6) elaborates that all revenues must come from activities that are ongoing and central to the operations of an entity. Increases in equity may come from sources that are not ongoing or central to the operations of an entity, and are therefore not revenue. Two examples of this are a) investment contributions by owners and b) foreign currency (or other) gains. Investment contributions by owners involve a transfer of assets (or assumption of liabilities) by an owner acting as an owner in exchange for an ownership stake. These transactions involving owners are generally outside the scope of ASC 606 and are instead accounted for under ASC 505 and 815-40.
The only accounting difference between a non-recurring exchange transaction and an ordinary exchange transaction will be its classification (gain/loss vs. revenue). Gains are increases in equity from non-recurring transactions, rather than from the ongoing and central operations of an entity. These gains will generally be subject to ASC 610 – Other Income, rather than ASC 606. Identical transactions that result in revenues for some entities may result in gains for others, depending on what constitutes a given entity’s ordinary activities. Consequently, ASC 610 directly incorporates ASC 606 guidance to account for the incidental sale of intangibles or PP&E.
When a party enters into a collaboration agreement it is generally agreeing to share in the risks and benefits of an activity or process, as opposed to obtaining goods or services as a customer (the outputs of an entity’s ordinary activities). Despite this, when collaborators obtain the outputs of an entity’s ordinary activities they are still customers.
(2) Transaction must be an exchange
Exchange transactions are reciprocal transfers where each party sacrifices and receives consideration that they deem to be of equal value (ASC 845-10-20). This is in contrast to other transactions that are not at arms-length, such as transactions with owners and contributions. To the extent that nonreciprocal transfers constitute the ordinary activities of an entity, these transfers may still be considered revenue (e.g. contribution revenue or tax revenue).
However, ASC 606 only applies to a subset of revenue transactions, specifically revenues from contracts with customers. Consequently, although ASC 606 eliminates the majority of industry specific revenue recognition guidance, contribution revenue will continue to be accounted for according to industry specific not-for-profit guidance found in ASC 958-605. It should be noted that not-for-profit entities still enter into transactions that are exchanges (either entirely or partially), including contributions such as membership dues or for naming rights. To the extent that such a transaction is an exchange, ASC 606 should be applied, with the residual treated as a contribution.
In addition to considering what constitutes an entity’s ordinary activities and whether a transaction is an exchange, it may be useful to consider whether the 5-step model could reasonably be applied. If an entity cannot identify promised goods or services (step 2) or cannot determine when control of promised goods or services transfers (step 5) this may be an indicator that a transaction is not an exchange transaction with a customer.
Example (Non-Recurring Sale)
Amy’s Ambulance Co. (AAC) sells cutting-edge ambulances to police stations and other emergency response providers. These ambulances contain sophisticated digital equipment to treat patients while traveling to the hospital. To stay at the top of the ambulance business, AAC invests heavily in R&D. This includes purchasing new computers for the research team on a regular basis (every two years) and selling the old computers. Is the regular sale of Computers by AAC subject to ASC 606?
Analysis: No, this is not a transaction with a customer because AAC’s central operations relate to the manufacture of ambulances, not the sale of computers. The sale of computers is an incidental activity that will lead to gains or losses, not revenues.
Bob Davis decided to donate $10 million dollars to the Atlanta hospital to fund development of a new neonatal children’s center. Bob’s generosity prompted the hospital to offer him the opportunity to name the hospital, and he determined that the new children’s center would be known as “Bob’s Babies.” Should Bob’s donation be accounted for under ASC 606?
Analysis: If Bob had donated the money without receiving naming rights, this would be a pure contribution transaction because there would be no exchange component. However, because Bob effectively paid for the right to name the children’s center, this transaction is part exchange and part contribution. To the extent this transaction is an exchange ASC 606 will apply. First the exchange portion subject to ASC 606 must be determined, perhaps by using an adjusted market approach and considering naming rights prices for other similar venues (perhaps performing arts centers and sporting arenas). Any residual amount would be a contribution and would have no performance obligations attached.
Comparison to ASC 605
The distinction between gains and revenues under ASC 605 comes from the general definition of revenue, but under ASC 606 this distinction is also based on the definition of a customer. This general definition of revenue is found in Con 6, which states that revenue is required to result from the ongoing or central activities of an entity. The definition of a customer under ASC 605 is merely “a user or reseller,” as opposed to the more detailed definition provided in ASC 606, which requires that the transaction be an exchange of goods or services that are outputs of an entity’s ordinary activities. Because of the simplicity of the ASC 605 definition of a customer, it is not a key point in determining which contracts are within the scope of ASC 605 guidance.
ASC 606 defines a customer as an entity that contracts to obtain goods (or services) that are an output of an entity’s ordinary activities in exchange for consideration. Goods sold that are not ordinary outputs are gains or losses, with similar measurement and recognition under the newly issued ASC 610. Non-exchange transactions may be considered revenue (e.g. contribution revenue), but are not considered contracts with customers subject to ASC 606. It is important to determine if a contract is with a customer before endeavoring to apply the ASC 606 standard.
- ASC 606-10-15-3; ASC 606-10-55-36 to 55-37.
- ASU 2014-09: “Basis for Conclusions.” BC 28, 53, 55.
- Concept Statement 6, “Elements of the Financial Statements,” par. 78-79.
- Deloitte, Revenue from Contracts with Customers: “Roadmap to applying ASU 2014-09.” February 2015. Section 3.2 “Scope of ASC 606.”
- FASB & IASB, TRG Memo 26: “Contributions.” 30 March 2015.
- PWC, “Revenue from contracts with customers.” August 2016. Section 2.4, “Identifying the customer.”