A company manufactures custom machinery. It charges customers an upfront non-refundable fee for setup and customization of the machinery, which represents a distinct service. The company then transfers control of the machinery over time. How should the company recognize revenue for the non-refundable upfront fee?
- ARecognize the entire fee as revenue when received.
- BDefer the fee and recognize it as revenue over the period the customer benefits from the customization, which is likely the period of control transfer for the machinery.
- CDefer the fee and recognize it as revenue over the period the customization services are provided.
- DRecognize the entire fee as revenue when the machinery is delivered.
Show answer & explanationAnswer & explanation
Correct answer: B. Defer the fee and recognize it as revenue over the period the customer benefits from the customization, which is likely the period of control transfer for the machinery.
Under ASC 606 (Revenue from Contracts with Customers), a non-refundable upfront fee for activities that do not transfer a good or service to the customer on its own (like setup) should generally be deferred. This fee is often an advance payment for future goods or services. Specifically, if the upfront activity (setup/customization) is not a distinct performance obligation but rather facilitates the transfer of other distinct goods or services (the ongoing use of the machinery), then the fee should be recognized as revenue over the period the customer benefits from the upfront service, which typically aligns with the revenue recognition pattern of the related goods or services. Since control of the machinery is transferred over time, the benefit from customization is also received over that period.
Why the other options are wrong
- A. This is incorrect; non-refundable upfront fees are generally deferred if they relate to future performance.
- C. While deferring is correct, recognizing it over the customization *service period* might be too short if the benefit extends beyond that period to the machinery's use.
- D. This would be appropriate if the fee was tied directly to the point-in-time delivery of the machinery, but here it's for customization over time.
Non-Refundable Upfront Fees (ASC 606)
Fees received from customers at the start of a contract that are not distinct performance obligations themselves but relate to future goods or services, requiring deferral and recognition over time.
- Assessed as to whether they represent a distinct performance obligation.
- If not distinct, defer and recognize over the period the customer receives the benefit.
- Often related to setup, initiation, or access to future goods/services.
Memory trick: Revenue's 5 Steps: Contract, Obligations, Price, Allocate, Recognize's Wise.