Contract costs under ASC 340-40: commissions and fulfillment costs

• Identify incremental costs of obtaining a contract and apply the one-year practical expedient
• Apply the three criteria for capitalizing costs to fulfill a contract
• Set an amortization period that includes anticipated renewals
• Test capitalized contract costs for impairment

Two kinds of capitalized cost

ASU 2014-09 added Subtopic 340-40 alongside Topic 606. It covers two types of cost related to customer contracts:

• Incremental costs of obtaining a contract: costs the entity would not have incurred if the contract had not been obtained. A sales commission paid on signing is the standard example.
• Costs to fulfill a contract that are not within another Topic (such as inventory, property and equipment or internal-use software).

Costs to obtain

Under 340-40-25-1, the entity recognizes an asset for incremental costs of obtaining a contract if it expects to recover them. Costs that would have been incurred regardless of whether the contract was obtained, such as a salesperson's base salary or travel to pitch a prospect, are expensed unless they are explicitly chargeable to the customer (340-40-25-3).

Who earns the commission does not matter; whether it is incremental does. Commissions paid to a sales manager on a team's signed contracts are incremental if they would not be paid without the contract. A bonus based on overall company results or subjective performance is not.

Practical expedient (340-40-25-4). The entity may expense incremental costs of obtaining a contract when incurred if the amortization period of the asset would have been one year or less. Note the test is the amortization period, not the initial contract term. If the commission relates to expected renewals, the period can be longer than the first-year contract.

Costs to fulfill

Under 340-40-25-5, the entity recognizes an asset for costs to fulfill a contract only if all three criteria are met:

1. The costs relate directly to a contract or to an anticipated contract the entity can specifically identify (direct labor, direct materials, allocations of costs that relate directly to the contract, costs explicitly chargeable to the customer, and other costs incurred only because of the contract).
2. The costs generate or enhance resources of the entity that will be used in satisfying performance obligations in the future.
3. The costs are expected to be recovered.

Under 340-40-25-8, these are always expensed: general and administrative costs not explicitly chargeable to the customer, costs of wasted materials, labor or other resources not reflected in the contract price, costs that relate to performance obligations already satisfied, and costs the entity cannot distinguish between satisfied and unsatisfied obligations.

Setup costs for a hosted service (data migration, configuration of the entity's own systems) are the common fulfillment asset.

Amortization

Under 340-40-35-1, the asset is amortized on a systematic basis consistent with the transfer of the goods or services it relates to. That can include goods or services under a specific anticipated contract, such as expected renewals. If a commission is paid on the initial contract and no commensurate commission is paid on renewals, the asset often relates to the expected customer relationship period, not just the initial term. If the expected pattern changes significantly, update the amortization prospectively as a change in estimate (340-40-35-2).

Impairment

Under 340-40-35-3, recognize an impairment loss to the extent the carrying amount exceeds the remaining consideration the entity expects to receive for the related goods or services, less the costs that relate directly to providing them that have not yet been expensed. Before this test, apply impairment guidance for assets in other Topics (such as inventory) first. Impairments of contract costs are not reversed.

Disclosures

340-40-50-2 and 50-3 require the judgments used to determine capitalized costs, the amortization method, closing balances by main category, and amortization and impairment for the period. Entities that are not public business entities (and are not the other entities listed in 340-40-50-4) may elect not to provide these. The commission amortization calculator and the SaaS commissions guide work through the numbers.

Commissions with an expected renewal