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Revenue recognition – Combining contracts and contract modifications

Date recorded:

Combining contracts

The Exposure Draft on revenue recognition included guidance on when multiple contracts should be combined and accounted for as a single contract. The guidance used the principle of 'price interdependence' in making this assessment. However, some respondents to the Exposure Draft felt the concept of 'price interdependence' was confusing. Some suggested using the principle in IAS 18 that contracts "are linked in such a way that the commercial effect cannot be understood without reference to the series of a transaction as a whole". A few respondents also raised the concern that it could be difficult to determine whether a discount for a particular contract was a result of price interdependency with another contract or because of a pre-existing customer relationship.

Based on consideration of the feedback received, the staffs proposed the final standard include a principle on when multiple contracts should be combined and accounted for as a single contract, supported by a list of indicators for when it may be appropriate to combine contracts. The principle they proposed was that an entity would account for two or more contracts as a single contract if the contracts were entered into at or near the same time and the amount of revenue recognition would differ depending on whether the entity accounts for the contracts together or separately.

One FASB member felt that the proposed principle involved a level of circularity; you have to determine if the revenue would be recognised differently to determine whether the contracts should be combined, in order to determine how the revenue should be recognised. He recommended that the principle and the indicators be combined. Other Board members agreed and suggested that the indicator of contracts being with the same, or a related party should also be included in the lead-in to the indicators.

Both Boards tentatively agreed on a principle of contracts that are interrelated should be combined, if they are entered into at the same time and generally with the same party (or a related party). Indicators of an interrelationship could include 1) the contracts were negotiated as a package with a single commercial objective, 2) the amount of consideration received in one contract depends on the performance of the other contract, or the goods and services in the contracts are closely interrelated or interdependent in terms of design, technology, or function.

Modifications of contracts

The Exposure Draft also included the concept of 'price interdependence' for determining whether to account for a contract modification as a separate contract or as part of the original contract. However, many comment letter respondents felt the proposals guidance on 'price interdependence' was confusing and would not be capable of being applied consistently.

Based on the comments received, the staff recommended an approach where if the modification only related to price, then the change would be allocated to the transaction price. However, if the contract modification added goods or services that are 1) distinct and 2) priced at their standalone selling price then those would be accounted for as additional goods or services. If those two criteria are not met, then the entity would re-evaluate all performance obligations and reallocate the transaction price.

The Boards generally had issues with the staffs' recommendation. One IASB Board member questioned what was meant by 'standalone selling price'. The staffs referenced the agenda paper which provided that a standalone selling price would consider an entity's relationship with a particular customer. Several Board members questioned whether that is truly a standalone sales price if customer relationships are taken into consideration.

The Boards then discussed an example of a home builder who is asked to build a separate stand alone garage and whether that would be considered a modification or a separate contract. The Boards mentioned there may be a variety of reasons that the home builder may charge the customer less then he would another party. A variation of that example was also discussed where the homeowner requested a modification in the plans to the house and the homebuilder was able to charge a premium based on the modifications.

One FASB member suggested that the performance obligation concept should be utilised rather than price interdependence. The Boards generally supported incorporation of the performance obligation concept and requested the staff to further consider the criteria based on indicators previously agreed upon for combining contracts.

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