ASC 606-10-32-25: Consideration Payable to a Customer

The framework for recognizing revenue from contracts with customers is governed by Accounting Standards Codification (ASC) 606. This standard ensures revenue is recognized when goods or services are transferred to a customer. The guidance in ASC 606-10-32-25 addresses situations where an entity provides consideration, such as payments or credits, back to its customer. Understanding this subsection is necessary for correctly determining the transaction price and the amount of revenue an entity will recognize.

Identifying Consideration Payable to a Customer

Consideration payable to a customer includes any cash an entity pays or expects to pay to its customer, as well as credits or other items that can be applied against amounts owed to the entity. This guidance also extends to payments made to other parties who purchase the entity’s goods or services from the original customer, often called a “customer’s customer.” The form of the consideration is diverse and includes common business practices intended to incentivize sales.

Examples of consideration payable to a customer include volume-based rebates, where a customer receives a cash payment or credit after reaching a certain purchase threshold. Other examples are customer coupons or vouchers that provide a discount on future purchases. In retail environments, payments such as slotting fees to secure shelf space, or cooperative advertising arrangements where an entity reimburses a customer for advertising costs, also fall under this definition.

The promise to provide this consideration does not need to be explicitly written in a contract. It can be implied by an entity’s established business practices, published policies, or specific statements. For example, if a company has a history of providing rebates to customers who meet certain criteria, this customary practice can create a valid expectation from the customer, even without a formal clause.

The Distinct Good or Service Test

The accounting for consideration paid to a customer is determined by one question: Is the entity receiving a distinct good or service from the customer in exchange for the payment? If the answer is yes, the payment is accounted for as a purchase. If no, the payment is treated as a reduction of revenue. To be considered “distinct,” a good or service must meet two criteria outlined in ASC 606.

The first criterion is that the customer must be able to benefit from the good or service on its own or with other readily available resources. This means the good or service has standalone value. For example, if a retailer provides advertising services for a manufacturer’s product, those services have value to the manufacturer independent of the products the retailer buys, as similar advertising could be purchased elsewhere.

The second criterion is that the entity’s promise to transfer the good or service must be separately identifiable from other promises in the contract. This involves assessing whether the good or service is integrated with other goods or services in the contract. For instance, if a software company pays a customer to perform consulting services for other clients, those services are likely distinct as they are not intertwined with the customer’s own software purchase.

Accounting as a Reduction of the Transaction Price

When consideration payable to a customer is not in exchange for a distinct good or service, the payment is accounted for as a reduction of the transaction price. This directly decreases the amount of revenue recognized. This is the default treatment under the standard, as the payment is effectively a discount or rebate on the goods or services sold to the customer.

The timing of this revenue reduction is linked to the underlying revenue transaction. The reduction is recognized at the later of when the related revenue is recognized or when the entity pays or promises to pay the consideration. For example, if a company offers a volume rebate earned throughout the year, it must estimate the expected rebate amount and reduce revenue as sales are made, updating the estimate each reporting period.

To illustrate, consider a manufacturer that sells $50,000 worth of products to a distributor. The manufacturer also agrees to pay the distributor a $2,000 slotting fee for shelf space. If the shelf space is not a distinct service, the $2,000 payment reduces the transaction price, and the manufacturer’s net revenue from this sale is $48,000.

Accounting as a Purchase from the Customer

If the consideration payable to a customer is for a distinct good or service that the customer transfers to the entity, the entity accounts for the payment as a separate purchase transaction. This means the payment is treated like any other purchase from a supplier. This results in the recognition of an asset or an expense, such as marketing expense, depending on the nature of what was received.

The measurement of this purchase is based on the fair value of the distinct good or service received. Fair value is the price that would be paid to acquire the same good or service in an arm’s-length transaction with a party other than a customer. If the fair value cannot be reasonably estimated, the entire payment must be treated as a reduction of the transaction price, even if a distinct service was received.

A specific rule applies when the cash paid to the customer exceeds the fair value of the distinct good or service received. In this scenario, the excess amount is not treated as part of the purchase. Instead, that excess is accounted for as a reduction of the transaction price. For example, a company pays a retailer $10,000 for an in-store marketing display. If the company determines the fair value of that display is only $8,000, the accounting is split. The company records a Marketing Expense of $8,000 and treats the remaining $2,000 as a reduction of revenue.