SWAP Amendment- Background
A Swap Amendment is a modification in the existing contract wherein a service is partially delivered as per the original terms of the contract and then the parties to the contract update the terms to include an additional service/product offering in exchange to the same existing service/product offering. As one service is being swapped with another, the arrangement is referred to as a ‘Swap Amendment’ in terms of the business.
Common Scenarios for Swap Amendment include:
The performance obligation term for 2 of the product codes namely, ‘AMS-FFF’, and ‘AMS-GGG’ is satisfied Point in Time, while that for the others is satisfied over the contract term of 12 months.
In the month of Sep-20XY, there is a change in the contract terms to offer one quantity of the product code ‘AMS-III’ instead of one quantity of ‘AMS-GGG’. Thus there is an arrangement to swap one quantity of the originally agreed product offering with an additional product. As only one of the 5 quantities of the existing product is being swapped, this arrangement is referred to as a ‘Partial Swap Amendment’.
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 here, that all the above criteria are satisfied between ABC Inc and the customer for identifying the agreement as a contract.
COMBINATION OF CONTRACTS
An entity shall combine two or more contracts entered into at or near the same time with the same customer (or related parties of the customer) and account for the contracts as a single contract if one or more of the following criteria are met:
In this Swap Amendment Scenario, ABC Inc will be considering the swapped service and the new service being provided in replacement as a single contract considering their policy of combining contracts based on the customer account number and a unique identifier which is the Billable ID of the customer. Since the new service is being added to the contract at a later date, i.e. Sep-20XY this amounts to Contract Modification.
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.
The below table layouts the performance obligations that ABC Inc will identify for the contract.
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 below table 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.
Note– The POB for the product ‘AMS-GGG’ is satisfied Point in Time. The revenue for the product ‘AMS-GGG’ is partially released in the month of Apr-XY as per the event uploaded in RevPro based on business requirements.
The following table shows the revenue in the case of ABC.
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 Sep-22, there is a change in the contract terms to offer one quantity of the product code ‘AMS-III’ instead of one quantity of ‘AMS-GGG’. Thus, there is an arrangement to swap one quantity of the originally agreed product offering with an additional product. As only one out of the 5 quantities of the existing product is being swapped, this arrangement is referred to as a Partial Swap Amendment. As per the modification framework, this shall be accounted for as a change to the existing contract.
In this case as per, ASC 606-10-25-13(a), since the remaining goods or services are distinct from the goods or services already provided under the original arrangement, the entity would in effect establish a “new” contract that includes only the remaining goods or services. The entity would allocate the following to the remaining performance obligations in the contract, thus accounting for the change Prospectively.
The services provided as per the changed terms are as mentioned below-
OBLIGATION IDENTIFICATION
There is an increase in the scope of the contract to include an additional line item, and simultaneously a decrease in the scope of the contract to exclude the line item being replaced.
The below table layouts the performance obligations that ABC Inc will identify for the contract.
ALLOCATION OF TRANSACTION PRICE TO OBLIGATION
There would be a change in the transaction price since there is a change in the contract. Also, ABC Inc reassesses its SSP every 6 months. Thus, Unit SSPs are also updated.
A Credit Memo of $ 1325.00 is uploaded to cancel one quantity of the Line Item being swapped (AMS-GGG), at the same time, a new line of $ 1325.00 is being added to the contract. Hence, we can see that the Total Net Sell Price (Sell Price- Credit Memo) equals the Total Sell Price prior to contract modification.
Calculations: (Ref product code – ‘AMS-GGG’)
Posted Revenue – Since the Contract modification is triggered in Sep-XY, the posted revenue is the revenue posted from Nov-XX to Aug-XY. Posted Revenue from Nov-XX to Aug-XY for this product code is $1,553.48 (Released in the month of Apr-XY since it is a Point-In-Time line)
Posted Percent – Posted Revenue as a percent of Net Sell Price. For the given product, Gross Revenue already recognized is $2,650.00. Net Sell Price would be the Sell Price as reduced by the Credit Memo value. Hence Net Sell Price = $6,625.00-$1,325.00 = $5,300.00 Thus, posted percent is $2,650.00/$5,300.00 = 0.5.
Allocatable Ext Price = Allocated Ext Price – Posted Revenue. For the given product, Allocatable Ext Price = $ 3,883.70 – $1,553.48 = $2,330.22.
As there is a change in the allocatable price, the consequently allocated price would change too.
Ext SSP = [(Unit SSP * Order Qty * Term)/12]* Unposted percent. For the given product, there is a reduction of quantity hence the updated quantity (4) would be considered. Thus, Ext SSP = (1,500.00 * 4 * 1) * 50% = $ 3,000. 00
Allocated price = [Sell Price * Ext SSP/ Total Ext SSP]. For this product, $ 28,141.04/$ 43,103.87 * 3,000.00 = $ 1,958.60
Adjustment Revenue (Carves) = Allocated Ext Price – Allocatable Ext Price. $ 1,958.60 – $ 2,330.22 = $ (371.62)
Note: This calculation also applies to the other lines of the contract.
The below table shows the new Transaction Price as per the modification.
RECOGNIZE REVENUE
The following table shows the revenue in the case of ABC, post Contract Modification. The Revenue Schedules until the month of Aug-XY remain the same whereas post-Sep-XY they are updated to reflect the catch-up of Revenue post Contract Modification.
Did you find this article on ASC 606 case study helpful? Click here for more Information on ASC 842, IFRS 16, IAS 17, ASC 606 and IFRS 15 or to write to us! We will be happy to answer any questions/queries regarding this and any other topics regarding ASC 842, IAS 17, IFRS 16, IFRS 15, Revenue Recognition and ASC 606.