Stand-ready obligations exist when a company promises to make itself available to provide goods and services to the customer over a period of time. Accounting for stand-ready obligations under Accounting Standards Codification (ASC) 606 often requires significant judgment. This article will help you determine whether a stand-ready obligation exists and what the appropriate accounting treatment is.
Determining Whether a Stand-Ready Obligation Exists
ASC 606 lists ten examples of goods or services that may be promised to a customer in a contract (explicitly or implicitly). Stand-ready obligations are specifically mentioned in ASC 606-10-25-18(e):
Providing a service of standing ready to provide goods or services (for example, unspecified updates to software that are provided on a when-and-if-available basis) or of making goods or services available for a customer to use as and when the customer decides.
Although this paragraph only mentions two types of stand-ready obligations, the FASB identified four types in its 2020 Q&A document. The four types are differentiated based on whether the entity, the customer, or neither has control over delivery of the good or service (FASB, Question 22):
- Type A. The entity has control over when the goods or services are delivered but needs to develop those goods or services further. Unspecified software updates are a common stand-ready obligation of this type.
- Type B. Neither the entity nor the customer has control over the delivery of the obligation. Weather-related services such as snow removal are common examples of this type.
- Type C. The customer has control over the delivery of the goods or services. An extended warranty requiring the entity to repair the product for its customer on an as-needed basis would be an example of this type.
- Type D. The entity is obligated to make a good or service continually available. Health club chains are a common example of this type of stand-ready obligation.
If a company’s promise seems to fit one of the four types above, the company should further evaluate the nature of the promise in the contract and determine whether the promise represents an obligation to stand ready or to provide the underlying goods or services. Some indicators that the promise represents an obligation to stand ready are that (1) the company is required to provide an unknown quantity of the good or service over the contract and (2) the quantity to be provided does not diminish as the customer consumes goods or services (KPMG, Question 3.4.3). A good example of both indicators can be seen in a typical health club membership with unlimited usage. The health club does not know exactly when or how many times the customer will visit during the contract period. In addition, no matter how many times the customer visits the club during the contract period, the number of remaining days the health club must make available to the customer does not diminish.
If the quantity of promised goods or services in the contract does diminish as the customer consumes those goods or services, the promise may still be a stand-ready obligation if the limit is not substantive but merely protective. For example, a limit of 100 machinery service calls per month may be protective if customers rarely approach that number of calls. In this case, the promised service is likely a stand-ready obligation to answer service calls. In contrast, if a customer buys ten coupons that each allow a single visit to the health club, then the promise is more likely to be the underlying good or service rather than the act of standing ready because the customer could easily reach the limit.
Not all stand-ready obligations represent a performance obligation. For example, a company may promise to stand ready to accept returns or provide refunds. The FASB decided that such promises do not constitute performance obligations and instead should be factored into the transaction price as variable consideration. A company’s promise to stand ready to repurchase an asset is also not a performance obligation. Finally, a stand-ready obligation must be distinct to be considered a separate performance obligation. Read Distinct Within the Context of the Contract for more information.
In September 2019, the Securities and Exchange Commission (SEC) asked Axon Enterprise to elaborate on how it recognizes revenue for certain contracts. In response, Axon described how it recognizes revenue for a stand-ready obligation in which it offers a minimum number of training cartridges (firearm ammunition) as well as unlimited additional cartridges:
Our unlimited TASER cartridge program is a commercial offering where not all of the promises are distinct. This program includes a promise of a fixed number of scheduled training cartridge deliveries during the term of the arrangement as well as a promise to stand-ready to deliver an unlimited number of cartridges and batteries for use in the line of duty at the customer’s request. We do not regularly offer on a standalone basis an arrangement for customers to purchase an unlimited number of duty cartridges. Training and duty cartridges can be used interchangeably in a training environment and since the customer has the contractual right to unlimited duty cartridges under the unlimited plan, they essentially have the right to unlimited cartridges that can be used in a training environment, which is substantially similar to having access to an unlimited number of training cartridges. (October 2019 letter to the SEC)
We apply ASC 606-10-25-18(e) and Transition Resource Group Memo No. 16 to this program and due to the unlimited nature of these arrangements in which we are obligated to deliver unlimited products at the customer’s request, we account for these arrangements as stand-ready obligations, and recognize revenue ratably over the contract term as this depicts the benefit to the customer of having ongoing access to cartridges evenly over that period of time.
When to Recognize Revenue for a Stand-Ready Obligation
If a company determines that a contract contains a stand-ready obligation as opposed to a promise to deliver a good or service, and that stand-ready obligation represents a distinct performance obligation, revenue should be recognized over time as the stand-ready obligation is satisfied. In its 2020 Q&A document, the FASB indicated that companies should not default to a straight-line revenue attribution method if such a pattern of recognition would not depict the entity’s performance of satisfying the performance obligation. As a result, companies must assess the nature of the underlying promise. For example, a company may consider the timing of transfer of the underlying goods or services or whether the company’s efforts (i.e., costs) are expended evenly throughout the period covered by the stand-ready obligation.
Example: Revenue Recognition Timing for a Health Club Chain
The revenue standard provides an example of a health club chain (Example 18, ASC 606-10-55-184 to 55-186). The company enters into a one-year contract with a customer to provide unlimited access to the health club facilities. The customer benefits from the company’s service of making the health club available, and the customer’s use of the facilities does not affect the remaining goods and services that the company has contracted to provide. The health club expends its efforts evenly over the contract period to keep the facility open for customer use. The standard concludes that the company should recognize revenue on a straight-line basis throughout the year.
Although the health club chain example depicts a situation where ratable recognition would be appropriate, other fact patterns might not lead to the same conclusion. For example, if it is more likely that the company will be required to perform at certain points in the contract, then more revenue should be allocated to those periods. For example, if a software company knows when it intends to release major updates, then straight-line recognition would be less appropriate, and more revenue should be allocated to the periods when the new release is being developed. However, if that company was instead periodically providing bug fixes and incremental improvements, straight-line recognition would be appropriate. A company may consider input and output methods in its analysis.
Example: Revenue Recognition for Snow Removal
The FASB 2020 Q&A document provides examples of accounting for stand-ready obligations. In one of these examples, a company contracts to clear snow off an airport’s runways for a year. Although such a contract may span an entire year, the airport receives most of the benefits during the winter months when snow is more likely and the company is expected to remove it. For these reasons, the company would conclude that recognizing significantly more (if not all of the) revenue during the winter months is appropriate.
Electronic Arts, Inc. offers monthly or annual subscriptions to its online gaming services and recognizes revenue over time. In August 2019, Electronic Arts received a comment letter from the SEC inquiring about the timing of its revenue recognition for these subscriptions. In response, Electronic Arts explained:
Origin Access, Origin Access Premier and EA Access (collectively “EA’s Subscriptions”) provide subscribers with a license to current games included within the subscription, future games and content to be added to the subscription, discounts and other member benefits during the subscription term. The Company believes these subscription offerings represent a single stand-ready obligation that is recognized ratably over the subscription period.
Based on ASC 606-10-25-27… we determined the recognition period for our arrangements with terms that extend beyond one month should be recognized ratably over the stated subscription term as continued online access is required to obtain the benefits of the subscription. (September 2019 letter to the SEC)
Four main types of stand-ready obligations exist. If a contract contains an obligation that fits one of these types, the terms should be evaluated to determine whether the obligation is to stand ready or to provide the underlying good or service. If a stand-ready obligation exists and is distinct, the company must use judgment to determine when to recognize revenue based on when the customer benefits from the transferred good or service and the nature of the company’s efforts to provide the good or service.
- ASC 606-10-25-18, 55-184 to 55-186
- Deloitte, “A Roadmap to Applying the New Revenue Recognition Standard.” July 2019. Section 5.4.2.
- EY, “Revenue from contracts with customers (ASC 606).” January 2020. Section 4.1.
- FASB, “Revenue Recognition Implementation Q&As.” January 2020. Question 22, Question 49.
- FASB, TRG Memo 16: “Stand-Ready Performance Obligations.” 26 January 2015.
- Grant Thornton, “Revenue from Contracts with Customers.” January 2019. Section 4.1.4.
- KPMG, “AASB 15: Potential Performance Obligation Pitfalls.” 12 April 2019.
- KPMG, Handbook: “Revenue Recognition.” December 2019. Section 4.5.30, Section 7.4.4.
- KPMG, Handbook: “Service Concession Arrangements.”April 2020. Question 3.4.3.