Question

Gary’s Baloons Information:

• Gary’s Balloons Inc. (or the “Company”) manufactures and leases hot air balloons to corporate and private tourism and advertising businesses as well as various other third-party customers.

• The Company entered into a contract with Harp Group, a performance arts company, to be the sole provider of hot air balloons for all its events for a period of 3 years.

• Harp Group holds weekly events, and Gary’s Balloons provides its hot air balloons for every event.

• After an initial three-year period, the contract between Harp Group and the Company is renewable in one-year increments.

• The Company’s average customer relationship period typically lasts for five years (the initial three-year term plus two one-year renewals).

• The Company has concluded that the contract does not contain a lease within the scope of ASC 840 nor of 842, and therefore the Company accounts for the arrangement as a contract with a customer within the scope of ASC 606.

• As an incentive to execute new customer contracts, the Company offers its sales representative a one-time $5,000 commission, which is earned and payable to the sales representative as soon as the contract is executed with the customer. No additional commission is paid to the representative upon renewal of the contract by the customer.

• The sales representative incurred $500 in travel costs to travel to Harp’s headquarters to perform a demonstration.

• The Company also incurred approximately $2,000 in external legal costs to draft the contract executed between the Company and Harp Group.

Questions:

1. Where within ASC 606 is guidance provided on how to account for incremental costs of obtaining a contract (if at all)?

2. Which of the costs mentioned above, if any, are incremental costs of obtaining the contract?

3. How might Gary’s determine the appropriate amortization method of any capitalized costs?

4. Which costs should be capitalized, if any, and over what period should the Company amortize each capitalized cost?

Answer 1

1. As per ASC 606, incremental costs of obtaining a contract (Eg. Sales Commissions) with a customer are required to be capitalized if an entity expects to recover those costs.

2. Commission of $ 5,000 paid to its sales representative is the incremental costs of obtaining the contract.

3. The method of amortization should be consistent with the timing of the transfer of goods and services to customers. Gary's should amortize the capitalized costs on a straight line basis since services are evenly provided over the contract period.

4. Following are the costs to be capitalized and the period of amortization:

• The incremental costs of $ 5,000 should be capitalized.
• As per ASC 606, the amortization period for a contract cost asset includes anticipated renewal periods when the entity concludes that it will continue to benefit from the contract cost asset over a period that is longer than the stated contract period. Since the Company’s average customer relationship period typically lasts for five years, the company should amortize the capitalized cost over a period of 5 years.