ASC 340-40, Other Assets and Deferred Costs – Contracts with Customers

Background:

The somewhat new revenue recognition standards started by Accounting Standards Update (ASU) 2014-09 added a subtopic to the Accounting Standards Codification (ASC), ASC 340-40, which addresses accounting for incremental costs incurred as part of obtaining or fulfilling contracts with customers within the scope of ASC Topic 606 on revenue from contracts with customers. The purpose of this subtopic is to create a consistent framework to account for contract costs. This is an often-missed area of the ASC that many companies lack knowledge of. It’s important to note and recognize that if your company adheres to ASC Topic 606 for its revenue recognition (generally, the five-step recognition method for analyzing contracts with customers), it may also be subject to ASC 340-40. Read on for more information about this accounting standard and how to apply it.

Defining Incremental Costs:

Incremental costs are costs that are incurred to obtain a contract with a customer that would not have been incurred if the contract had not been obtained. Examples of incremental costs include commissions paid upon successful signing of a contract and bonuses paid based on quarterly sales targets. Other costs, such as legal fees for drafting contracts, travel expenses to pitch contracts, and salaries for salespeople working exclusively on obtaining new customers, are not considered incremental costs because they would have been incurred whether or not the contract was obtained.

Accounting Treatment:

Incremental costs to obtain a contract are capitalized and recorded as assets if they both (1) relate directly to a contract greater than one year in length and (2) they are expected to be recovered. Incremental costs to fulfill a contract are capitalized if they (1) relate directly to a current or a specific anticipated contract, such as a contract renewal, (2) the cost generates or enhances a resource that is used to fulfill performance obligations, and (3) the cost is recoverable.

Incremental costs incurred on contracts whose terms are one year or less are expensed when incurred.

Capitalized incremental costs are amortized on a straight-line basis over a period consistent with the length of the contract or the transfer of goods or services to which the asset relates. If the timing of the transfer of goods or services changes significantly at a point during the contract period, the entity should revise the amortization period to reflect such change on a prospective basis.

An impairment analysis should be performed at the end of the reporting period and when an event occurs that indicates that the capitalized contract costs may no longer be recoverable. If capitalized costs exceed the amount of consideration an entity expects to receive in future periods, the difference should be recognized as a loss in the entity’s financial statements.

Disclosures:

An entity is required to disclose judgments made in determining costs incurred to obtain or fulfill contracts with customers, the method used to determine the amortization period of capitalized costs, the amount of amortization, and any impairment losses recognized in the reporting period.

In Summary:

If your company incurs costs related to securing and fulfilling contracts whose terms are longer than one year, chances are ASC 340-40 applies to you. Make sure that you’re following this and other standards to ensure full compliance with US GAAP, clean audits, and proper governance. There’s also a certain financial benefit to adopting and implementing ASC 340-40, as expenditures that would otherwise be expensed in one period could potentially be deferred over time, which also better matches revenue under ASC 606 with underlying and related expenses. As always, if you have any questions about this subject (or any others), please connect with the Cerini & Associates Technology and Startup services group.

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