the customer obtains control of the good, then the entity may elect to account for the shipping and handling as activities to fulfill the promise to transfer the good, in accordance with paragraph 18b of FASB ASC 606-10-25. The entity would have to make an accounting policy election and the application of the election would have to be consistently applied to similar types of transactions. Therefore, if the accounting policy election is made, an entity would not evaluate whether shipping and handling activities are promised services to its customers. Keep in mind that if revenue is recognized for the related good before the shipping and handling activities occur, the related costs of those shipping and handling activities will need to be accrued.
It is not uncommon for entities to transfer control of a good to a customer prior to that good shipping. This is generally referred to as free on board (FOB) shipping point. Entities are required to assess whether shipping and handling activities associated with these FOB shipping point transactions represent a separate performance obligation to a customer. Keep in mind that control of that good has already transferred to the customer and therefore the shipping and handling activities are not part of the entity’s promise to transfer the good to the customer.
Prior to FASB ASC 606, entities entering into FOB shipping point transactions with customers did not generally assess whether the associated shipping and handling was considered to be a separate deliverable (deliverable is a term used in superseded FASB ASC 605, Revenue Recognition). Given this, some entities may fail to realize that they must make an accounting election to not evaluate whether the shipping and handling are promised services to customers, meaning possible separate performance obligations. Note this election will need to be applied consistently to similar transaction types.
The following is some helpful information for entities electing to account for shipping and handling as activities to fulfill the promise to transfer the good to a customer in accordance with paragraph 18b of FASB ASC 606-10-25:
Disclose the election of this policy in the notes to the financial statements in accordance with FASB ASC 235, Notes to Financial Statements.
Apply the policy consistently to similar transaction types.
Do not lose sight of the fact that if revenue is recognized for the related good before the shipping and handling activities occur, the related costs of those shipping and handling activities will need to be accrued.
Knowledge check
1 Which statement best describes an implied promise in a contract with a customer?It needs to be explicitly stated in the contract.May be part of an entity’s customary business practice.May be part of an entity’s competitor’s customary business practice.Creates an unreasonable expectation of the customer.
2 An entity may elect to not account for shipping and handling activities as a separate performance obligation providing:The shipping and handling activities occurred before the customer obtains control of the goods.The shipping and handling activities occurred after the customer obtained control of the good.The shipping and handling activities were an established customary business practice by the entity.The shipping and handling activities were explicitly stated in the contract with the customer.
Determining when a good or service has been identified as distinct
When goods and services are distinct
In order to determine whether a promised good or service in a contract is a separate performance obligation, an entity will need to assess whether that good or service is distinct. Therefore, FASB ASC 606 explains that a good or service promised to a customer is distinct if both of the following criteria are met:
The customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer (that is, the good or service is capable of being distinct).
The entity’s promise to transfer the good or service to the customer is separately identifiable from other promises
A series of distinct goods or services has the same transfer pattern to the customer if both of the following criteria are met:
Each distinct good or service in the series that the entity promises to transfer to the customer would meet the criteria to be a performance obligation satisfied over time.
The same method would be used to measure the entity’s progress toward complete satisfaction of the performance obligation to transfer each distinct good or service in the series to the customer.
In assessing whether an entity’s promises to transfer goods or services to the customer are separately identifiable at the inception of the contract, an entity will need to determine the following:
Whether a customer can benefit from the good or service if the good or service could be used, consumed, sold for an amount that is greater than scrap value, or otherwise held in a way that could generate economic benefits. Keep in mind that with some goods or services a customer may be able to benefit from a good or service on its own.
Whether a customer is able to benefit from the good or service only in conjunction with other readily available resources. A readily available resource is a good or service that is sold separately (by the entity or another entity) or a resource that the customer has already obtained from the entity (including goods or services that the entity will have already transferred to the customer under the contract) or from other transactions or events. Various factors may provide evidence that the customer can benefit from a good or service either on its own or in conjunction with other readily available resources. For example, if an entity regularly sells a good or service separately indicates that a customer can benefit from the good or service on its own or with other readily available resources.
The contract
Ace Partners, a software developer, enters into a contract with a customer, Jones Inc., to transfer a software license, perform an installation service, and provide unspecified software updates and technical support (online and telephone) for a two-year period. ACE Partners sells the license, installation service, and technical support separately. The installation service includes changing the web screen for each type of user (for example, marketing, inventory management, and information technology). The installation service is routinely performed by other software developers and does not significantly modify the software. The software remains functional without the updates and the technical support.
Assessment considerations
Ace Partners assesses the goods and services promised to the customer Jones Inc. and observes that the software is delivered before the other goods and services and remains functional without the updates and the technical support.
Ace Partners took into consideration
