Manual line in Contract Modification- Background

A contract modification scenario/practice where an existing contract is extended as per new terms and conditions between parties by way of a new contract. A new contract has been entered into as a result of an extension of the contract. Revenue will be recognized under the new contract. The remaining future scheduled revenue of the existing contract is allocated to the new contract. This case study helps to demonstrate how the future scheduled revenue of the old contract is being recognized under the new contract.

CASE – (Extension of a contract under new RC)

ABC Inc, a US-based company entered into a contract with PQR on May 01, 20XX at an agreed price of $24,000.00 to provide services w.r.t 3 product codes namely, ‘ABC’, ‘PQR’, ‘XYZ’ for 12 months. The contract ends on April 30, 20XY. The performance obligation of the product code namely, ‘PQR’ is satisfied Point in Time (in a single month), while that for the ‘ABC’ and ‘XYZ’ is satisfied over the contract term of 12 months.

On March 01, 20XY, there is a change in the terms of the contract which results in the inception of the new contract with the updated selling price of $30,000.00, and future scheduled revenue (deferred revenue) of the former contract shall be recognized in the new contract.

To bring this scenario into effect in RevPro, we upload a Credit Memo amounting to future scheduled revenue (deferred revenue) of the old contract as of the date of the contract change. Hence, the contract liability of the old contract becomes Nil. Further, a manual line amounting to the deferred revenue of the prior contract is uploaded along with the new contract.

TREATMENT UNDER ASC 606

CONTRACT IDENTIFICATION

A contract is an agreement between two or more parties that creates enforceable rights and obligations. This section discusses the steps to determine whether a contract exists and specific considerations that may impact that determination. Each contract will need to go through this evaluation.

Per ASC 606-10-25-1, the five criteria for identifying a contract are as follows:

Assuming, that all the above criteria are satisfied between ABC Inc and the customer for identifying the agreement as a contract.

OBLIGATION IDENTIFICATION

A performance obligation is a promise in a contract with a customer to transfer a good or service to the customer. If an entity promises in a contract to transfer more than one good or service to the customer, the entity should account for each promised good or service as a performance obligation only if it is (1) distinct or (2) a series of distinct goods or services that are substantially the same and have the same pattern of transfer.

PRICE FOR TRANSACTION

The transaction price is the amount of consideration to which the Company expects to be entitled in exchange for transferring goods or services to a customer, excluding amounts collected on behalf of third parties such as sales taxes.

In the case of ABC Inc, the determination of transaction price is straightforward based on what is being charged to the customer i.e. only Fixed consideration.

ALLOCATION OF TRANSACTION PRICE TO OBLIGATION

For a contract that has more than one performance obligation, an entity should allocate the transaction price to an amount that depicts the amount of consideration to which the entity expects to be entitled in exchange for satisfying each performance obligation. The performance obligation for allocation will be considered as each distinct separate performance obligation, i.e. let us say there are two separate support services provided within the same contract, even though the performance obligation is the same i.e. “Support”, but for allocation purposes, it will be considered as two separate performance obligation and both the support services will participate in the allocation representing the amount of consideration.

As per the ASC 606 Model, the table below shows the Transaction Price and the Allocations based on the Standalone Selling Price for this contract.

RECOGNIZE REVENUE

An entity should recognize revenue when (or as) it satisfies a performance obligation by transferring a promised good or service to a customer. A good or service is transferred when (or as) the customer obtains control of that good or service. For each performance obligation, an entity should determine whether the entity satisfies the performance obligation over time by transferring control of a good or service over time. If an entity does not satisfy a performance obligation over time, the performance obligation is satisfied at a point in time.

The below table layouts the performance obligations that ABC Inc will identify for the contract.

The following table shows the revenue in the case of ABC.

RECOGNIZE REVENUE (initial)

The table below shows the waterfall of the revenue throughout the tenure of the initial contract. (Deferred revenue after termination is highlighted in red)

(Note: The waterfall demonstrated in the table below is pro-rated monthly and not daily)

RECOGNIZE REVENUE (upto Termination of contract)

CONTRACT MODIFICATION

As per ASC 606, whenever an entity and its customer agree to change what the entity promises to deliver (i.e., the contract’s scope) or the amount of consideration the customer will pay (i.e., the contractual price), there is a contract modification. Consequently, whenever the enforceable rights and obligations in a contract with a customer change, a contract modification is present and the modification framework should be applied.

In the present case, in the month of Mar-22, there is a change in the terms of the contract resulting in the termination of the contract by way of bringing a Credit Memo for the future scheduled revenue. Hence, there is no further Contract Liability for the existing contract. A new contract has been entered into by both parties which shall be uploaded with the manual line in RevPro (not available in the contract from the upstream system) amounting to the future scheduled revenue of the previous contract i.e. $24000 – $21642.69 = $2357.31.  As per the modification framework, this shall be accounted for as a change to the existing contract.

OBLIGATION IDENTIFICATION

There is an increase to the scope of the contract to include an additional line item. A new line with Line Item “XFER-ADJ” is uploaded with the contract to include deferred revenue of the terminated contract. The selling price of the manual line is allocated to other products which eventually recognizes the revenue.

The below table layouts the performance obligations that ABC Inc will identify for the contract.

GENERAL STEPS FOR MANUAL LINE IN CONTRACT MODIFICATION:

UPLOADING MANUAL LINE IN REVPRO (RELEVANT DETAILS)

SSP CONFIGURATION FOR MANUAL LINE

SSP and Ext SSP of the manual line is configured to be $0 in RevPro by the formula ‘’SSP= Ext. Sell Price*0”. The purpose of the manual line is to have carves adjustments. There’s no allocation to the manual line.

Carves adjustments done by the manual line result in additional revenue (Deferred revenue from the old contract) being allocated to the remaining lines of the new contract as presented in the waterfall below.

RECOGNIZE REVENUE

The following table shows the revenue of the new contract post-contract modification (manual line addition) in the case of ABC.

(Note: The waterfall demonstrated in the table below is pro-rated monthly and not daily)

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