Modification is not a separate contract

A modification that does not meet both of the criteria to be accounted for as a separate contract is accounted for as an adjustment to the existing contract, either prospectively or through a cumulative catch-up adjustment. The determination depends on whether the remaining goods or services to be provided to the customer under the modified contract are distinct. In some cases, the remaining goods

provide specific guidance in this situation, but states that effects of the modification should be accounted for in a manner consistent with the objectives in the modification guidance. That is, a reporting entity would apply a combination of the methods described in RR 2.9.3.1 and RR 2.9.3.2, which may require judgment.

2.9.3.1 Modification is accounted for prospectively

A reporting entity should account for a modification prospectively if the modification is not a separate contract (as described in RR 2.9.2), but the remaining goods or services are distinct from the goods or services transferred before the modification. This type of contract modification is effectively treated as the termination of the original contract and the creation of a new contract. The contract consideration is allocated to the remaining performance obligations after the modification, including any unsatisfied performance obligations from the original contract. The amount of allocated consideration is the sum of any unrecognized consideration initially included in the transaction price of the contract before the modification and any additional consideration promised as part of the modification.

A reporting entity will also account for a contract modification prospectively if the contract contains a single performance obligation that comprises a series of distinct goods or services, such as a monthly cleaning service (refer to RR 3.3.2). In other words, the modification will only affect the accounting for the remaining distinct goods and services to be provided in the future, even if the series of distinct goods or services is accounted for as a single performance obligation.

Example RR 2-16 and Example RR 2-17 illustrate contract modifications accounted for prospectively.

This concept is also illustrated in Example 7 of the revenue standard (ASC 606-10-55-125 through ASC 606-10-55-128).

EXAMPLE RR 2-16

Contract modifications — series of distinct services

ServeCo enters into a three-year noncancellable service contract with Customer for $450,000

($150,000 per year). The standalone selling price for one year of service at inception of the contract is

$150,000 per year. ServeCo accounts for the contract as a series of distinct services (refer to RR 3.3.2).

At the end of the second year, the parties agree to modify the contract as follows: (1) the fee for the third year is reduced to $120,000; and (2) Customer agrees to extend the contract for another three years for $300,000 ($100,000 per year). The standalone selling price for one year of service at the time of modification is $120,000.

How should ServeCo account for the modification?

Analysis

The modification would be accounted for as if the existing arrangement was terminated and a new contract created (that is, on a prospective basis) because the remaining services to be provided are distinct. The modification should not be accounted for as a separate contract, even though the

remaining services to be provided are distinct, because the price of the contract did not increase by an amount of consideration that reflects the standalone selling price of the additional services.

ServeCo should reallocate the remaining consideration to all of the remaining services to be provided (that is, the obligations remaining from the original contract and the new obligations). ServeCo will

recognize a total of $420,000 ($120,000 + $300,000) over the remaining four-year service period (one year remaining under the original contract plus three additional years), or $105,000 per year.

EXAMPLE RR 2-17

Contract modifications — modification accounted for on a prospective basis

Supplier enters into a noncancellable contract with Retailer to supply 100,000 goods on an annual basis for $3 per unit for three years. At the beginning of the third year, Supplier and Retailer agree to renegotiate the contract because the market price for the goods has declined. Under the modified agreement, the parties agree to (1) extend the contract for an additional year (same fixed annual quantity) and (2) reduce the price per unit to $2 for the remaining 200,000 units to be delivered.

Supplier also agrees as part of the modification to make a one-time payment of $10,000 to Retailer.

There is no dispute between the parties regarding prior performance, and both parties have performed according to the terms of the contract.

Supplier concludes the remaining goods are distinct from those previously delivered and concludes the additional consideration does not reflect standalone selling price.

How should Supplier account for the modification?

Analysis

Supplier should account for the modification on a prospective basis. The transaction price of

$390,000 ($2 per unit x 200,000 remaining goods less $10,000 payment to Retailer) should be allocated to the remaining performance obligations, resulting in revenue of $1.95 per unit ($390,000 / 200,000 goods). The $10,000 payment to Retailer is a reduction of the transaction price allocated to the remaining goods in this fact pattern because the payment was made in conjunction with the renegotiation of the contract and there is no indication that the payment relates to prior performance.

In contrast, if there was evidence of a dispute or failure to perform according to the contract terms related to the previously delivered goods, this might indicate that Supplier agreed to make a concession that reduces the transaction price for the previously delivered goods. In that case, the amount that represents a concession would be recorded immediately. Determining when a portion of a modification is in substance a price concession could require significant judgment. This concept is illustrated in Example 5, Case B of the revenue standard (ASC 114 through ASC 606-10-55-116 ).

Question RR 2-5 addresses the accounting for a contract asset when a contract is modified.

Question RR 2-5

Should an existing contract asset be written off as a reduction of revenue when a modification is accounted for as the termination of the original contract and creation of a new contract?

PwC response

Generally, no. Although the original contract is considered “terminated,” modifications of this type

consider, however, whether the facts and circumstances of the modification result in an impairment of the contract asset. Refer to US Revenue TRG Memo No. 51 and the related meeting minutes in

Revenue TRG Memo No. 55 for further discussion of this topic.

2.9.3.2 Modification results in a cumulative catch-up adjustment

A reporting entity accounts for a modification through a cumulative catch-up adjustment if the goods or services in the modification are not distinct and are part of a single performance obligation that is only partially satisfied when the contract is modified. A reporting entity first updates the measure of progress and transaction price of the contract based on changes to scope or price as a result of the modification. The cumulative catch-up adjustment is calculated by applying the revised measure of progress to the revised transaction price, which could result in an immediate increase to or a reduction of revenue in the period of the modification. This concept is illustrated in Example 8 of the revenue standard (ASC 606-10-55-129 through ASC 606-10-55-133).

Modifications of contracts that include a single performance obligation that is a series of distinct goods or services will not be accounted for using a cumulative catch-up adjustment; rather, these

modifications will be accounted for prospectively (refer to RR 2.9.3.1).

Example RR 2-18 illustrates a contract modification accounted for through a cumulative catch-up adjustment.

EXAMPLE RR 2-18

Contract modifications — cumulative catch-up adjustment

Builder enters into a two-year arrangement with Customer to build a manufacturing facility for

$300,000. The construction of the facility is a single performance obligation. Builder and Customer agree to modify the original floor plan at the end of the first year, which will increase the transaction price and expected cost by approximately $100,000 and $75,000, respectively.

How should Builder account for the modification?

Analysis

Builder should account for the modification as if it were part of the original contract. The modification does not create a performance obligation because the remaining goods and services to be provided under the modified contract are not distinct. Builder should update its estimate of the transaction price and its measure of progress to account for the effect of the modification. This will result in a cumulative catch-up adjustment at the date of the contract modification.