More Revenue ReconcilliationPosted: October 14, 2019
I recently responded to another question about revenue recognition on TXCPA Exchange that I thought everyone might benefit from seeing.
Question – I have a situation where our firm has completed all the professional services on a contract, but the client wants more work done that we have agreed to do for free and that is outside the scope of the original agreement. We have completed all the milestones in the contract and we have customer acceptance for those milestones. Would I be able to recognize the remaining milestone revenue on the contract or do I need to hold some revenue back for the free services that are outside the original scope?
Response – The situation described sounds like a potential contract modification, but, as always with the new revenue standard, the devil is in the details. The description says all of the performance obligations are done, but the client wants more work completed. Did the client approach the firm for additional work before the work was done, the day the work was done or a year after the work was done? If it was a year after, the two pieces of work are not related and we would only need to worry about the work being potentially related to a yet unsigned future contract, but I doubt that is the case given your question.
A second question is around how often these types of adjustments are made under contracts. If the firm regularly does additional work (and I do not mean more than 50% of the time, but only that it happens enough to know additional work is a possibility), then the standard would say you probably should have anticipated such a potential event and held revenue in reserve up front. Assuming that is not the case, and you determine it is a modification of a contract and not pre-work being done on a subsequent contract, we then have to deal with the contract modification section of the revenue standard. The modification is a separate contract if the scope increases; i.e., more work is being done (sounds like the case here) AND the price of the contract increases by an amount that reflects standalone selling prices of the additional work (not the case here, as the question says the work is for free). That leads us to three options under the contract modification section:
1) The new contract is a termination of the old contract and creation of a new – the key here is that the remaining services are distinct from the services previously performed. If that is the case, you take any remaining unrecognized revenue from the original contract + any new revenue (none in this case) and recognize the revenue over the remaining services to be performed.
2) The new contract is a modification of the existing contract if the remaining services are not distinct. In this case, you take the revenue from the entire initial contract + the modified contract (zero in this case) and respread the revenue over all the services to be performed and change the revenue recognized to date (potentially resulting in a decrease to revenue in this situation) and then recognize the remaining revenue as the services are performed.
3) A combination of 1 and 2, if the remaining services are a combination of the situations outlined above.
A big key to determining how to handle contract modification is determining if the additional services (or goods) are distinct. That determination is made using the same rules under step 2 for determining what performance obligations are distinct.