SmokeyMan LO: Virtual Goods Case Study

By and April 14, 2017Case Study

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 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 based on each class. Antics’ ability to analyze and group customers appropriately is dependent on the sophistication of its systems and historical data. In this case, it is assumed that Antics has sufficient systems and historical data to make reasonable and appropriate estimates.

On July 5, 2016 Antics processed about 10,000 purchase transactions in SmokeyMan LO for about 7,300,000 SmokeyCoins and a total of $60,400. Antics concludes that these purchases consist of three classes of players: (1) casual, (2) moderate, and (3) heavy. Players within each class have been determined by Antics to have similarities of player life (i.e. how long players use the games) and gaming behaviors (i.e. the types of virtual goods selected when exchanging SmokeyCoins). The moderate users are deemed to be about 30% of this day’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 making a purchase of SmokeyCoins. Further, both buyers and sellers 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 are 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. If goods or services are deemed incapable of being distinct and/or not separately identifiable, they are bundled into a single performance obligation. Promised goods or services, or bundled goods or services, can be distinct or be a series of distinct goods or services. The result of this analysis is a list of all the performance obligations of a contract that will form 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, 2016 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 customers’ discretion. Antics must maintain its servers to display SmokeyCoins (and virtual goods subsequently received in exchange for these purchased SmokeyCoins) if-and-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 5. Recognize revenue when (or as) the entity satisfies a performance obligation below for further analysis on this point). Accordingly, this stand-ready obligation meets the criteria of 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.

Antics’ 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 on July 5, 2016 with the moderate class of customers. 

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 made based on the standalone selling price (SSP) of each performance obligation. Often, the SSP is not observable; e.g. 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 as:

Screen Shot 2017-04-14 at 9.38.10 AM

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 set forth 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:

a. The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs…

b. The entity’s performance creates or enhances an asset…that the customer controls as the asset is created or enhanced…

c. 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 towards 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, as may exist in many service contracts like a Software-as-a-Service (SaaS) arrangement. 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 to be 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. Revenue allocated evenly to the 120 distinct service periods is as follows:

Alternative View

An alternative view considers providing any 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 to the player. The obligation and service of standing ready is not delayed until a future exchange for virtual goods, but 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.).

ASC 605 Comparison

ASC 605 does not provide specific guidance for the freemium gaming industry. In the absence of such guidance, the industry has developed common approaches for recording transactions similar to those described in the case above. In general, companies establish a policy of recognizing revenue using a game-, user-, or item-based model. Game-based models begin recognizing revenue at the transaction date over a period representing the remaining life of the game. Revenue recognition under user-based models begins at the transaction date and continues over an estimated term of the user’s life. Finally, item-based models begin to recognize revenue when the virtual good is initiated in the game and end at either the item’s expiration or the end of the game or user life. The choice of model is largely determined by the level of data available from a company’s systems (i.e. if the company lacks sophisticated systems capable of tracking item-based data, the item-based model is not likely possible).

Like ASC 605, ASC 606 does not provide specific guidance for freemium gaming transactions. However, in contrast, conclusions reached under ASC 606 should not be based on common industry practices, but on the promised goods or services included in the contract. As such, under ASC 606 revenue recognition is likely to be different from the item-based model because the stand ready obligation begins at the transaction date. Therefore, revenue is not delayed until a virtual good is received in exchange for virtual currency or subsequently activated in the game. Companies must continue to estimate the duration of contract promises, and these estimates should consider factors such as user life.

Resources Consulted


Author Andrew Bellomy

Andrew has previously interned with KPMG, where he will begin full-time following graduation. Aside from accounting, Andrew enjoys playing the guitar and hiking with his wife and two children.

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