Memorandum

Re: Price Concession from contracts with customers under ASC 606-10.

Background.

Upscale Management Co. (the “Company”) entered into a five-year contract to provide hotel
management services to Second City Hotels (the “Customer”). The contract had a fixed price of
$10,000 per day. Some of the Company’s obligations to provide integrated management services
include but are not limited to hiring and managing employees, procuring goods and services,
advertising, and marketing at one hotel property owned by the Customer, and other occasional
duties to keep the hotel running. 

With COVID-19 hitting in March 2020, both enterprises agreed to lower the price for the
remaining three years of integrated services to $8,000 per day after the Company has already
provided two years of integrated services and recognized revenue of $7.3 million.

The main question arising, in this case, is whether the price concession
represent a change in transaction price or a contract modification under ASC 606-10.

Questions for Analysis:

 Because the only modification within the contract is a decrease in the transaction price,
should the agreement be accounted for as a contract modification under ASC 606-10?
 Does the price concession qualify the remaining three years to be considered as a separate
contract from the original one.?
 Based on the above facts and questions, how should the Company account for the price
concession under ASC 606?

Applicable Authoritative Literature:

 FASB Accounting Standards Codification (ASC) 606-10, Revenue from Contracts with
Customers, Overall

Discussion of Alternatives:

Alternative #1. The Company must consider this price concession just as a change in transaction
price.

It is appropriate to reiterate that not all price concessions are related to a contract modification.
606-10-32-42 points out that after contract inception, the transaction price can change for various
reasons, including the resolution of uncertain events or other changes in circumstances that
change the amount of consideration an entity expects to be entitled in exchange for the promised
goods or services. This paragraph simply means that any change related to a circumstance that
modifies the amount of consideration an entity expects to be entitled in exchange for the
promised services may be considered a transaction price, but not necessarily a contract
modification.

For this case, the Company might consider the price concession as an agreement that simply
changes the parties' rights and obligations after the contract's inception. Given that the
modification was approved by both parties to the contract, the management can go ahead and
allocate changes in the transaction price on the same basis as at contract inception.

Alternative #2. The Company must consider this price concession as a contract modification.

While it seems clear that a contract between the Company and the Customer existed at the
agreement's inception in accordance with both ASC 606-10-25-1 and IFRS 15 paragraph 9, the
economic downturn resulting from the COVID-19 pandemic drove both entities to agree on a
new price for the remaining three years of their contract. One of the questions arising from this
case is whether the price concession due to COVID-19 is considered a substantial change in facts
and circumstances under ASC 606-10, necessitating a reassessment of the contract.

Following ASC 606-10-25-5, if a contract with a customer meets the criteria mentioned in ASC
606-10-25-1 at contract inception, an entity shall not reassess those criteria unless there is an
indication of a significant change in facts and circumstances. The price concession, in this case,
gives evidence that the Customer's ability to pay its consideration has deteriorated significantly
due to the COVID-19 pandemic effects. Thus, I may conclude that this economic challenge faced
by the Customer is a substantial change in facts and circumstances necessitating a reassessment
and perhaps a modification of this contract.

606-10-25-12 clearly attests that an entity shall account for a contract modification as a separate
contract only if the scope of the contract increases due to the addition of promised services and
the price of the contract increases by an amount of consideration. In this scenario, however, we
notice that the contract price didn't increase, and there were no other changes regarding the terms
and scope of the initial agreement, which rid of the idea of a separate contract. 606-10-25-10
points out that a contract modification exists when the parties to a contract approve a
modification that either creates new or changes existing enforceable rights and obligations of the
parties to the contract. With this price concession, both parties to the agreement have
experienced changes either in their rights or obligations related to the contract’s price.
A guide published by Deloitte on June 29, 2020, confirms that a contract modification that
changes only the price of the contract (and not the contract’s scope) would not be accounted for
as a separate contract.
I believe Deloitte’s conclusion would apply to this scenario, given that the price concession does
not add distinct services to the original agreement between the Company and the Customer. The
same guide explains further that any modification that only decreases the price a customer must
pay for goods or services to be transferred in the future would not be accounted for as a separate
contract.

That having been said, the Company would consider ASC 606-10-25-13, which attests that if a
contract modification is not accounted for as a separate contract following paragraph 606-10-25-
12, an entity shall account for the promised goods or services not yet transferred at the date of
the contract modification. As the modification in the case concerns only a change in the
transaction price, it should not be accounted for as a separate contract given that it does not add
any promised services within the original agreement.

Because the remaining hotel management services are distinct from the services already provided to the
Customer, the company would prospectively account for the modification following ASC 606-10-25-13(a).
As a result, the company does not need to adjust the $7.3 million revenue previously recognized; however, it
must recognize the reduced daily fee of $2,000 as revenue on a prospective basis.

Allocation of the new transaction price to the performance obligations.

As this contract requires the Company to fulfill multiple performance obligations, management
must follow step four in the five-step revenue recognition process to allocate the $8,000 daily
transaction price to each performance obligation in proportion to its standalone services price.
Because the standalone selling price is not directly observable due to the nature of promised
services, the Company will apply ASC 606-10-32-33, which requires entities to estimate the
standalone selling price at an amount that would result in the allocation of the transaction price
meeting the allocation objective.

606-10-32-34 establishes the list of suitable methods for estimating the standalone selling price
of a good or service when dealing with revenue from contracts with customers. However, for this
scenario, the Company may use a combination of methods to determine the standalone service
price since the entity might be required to perform other obligations on certain given days. ASC
606-10-32-35 states that the residual approach may be used in some situations to determine the
aggregate standalone selling price of two or more goods or services with highly variable or
uncertain standalone selling prices. By evaluating and possibly combining some of these
methods, the Company won't need to constantly reevaluate its allocation techniques and
determine the best allocation each time it performs services on a given day.
In this case, the contract modification must be accounted for as if the initial five-year
arrangement is terminated and a new three-year contract is created on a prospective basis since
the remaining services to be provided are distinct. As a reminder, this modification should not be
accounted for as a separate contract, even though the remaining services to be provided are
distinct, given that the contract price did not increase by an amount of consideration. The
Company should reallocate the new consideration to all the remaining services to be provided
from the initial contract and the new obligations. As such, it will recognize $ 8.76 million over
the remaining three-year service period.

Because other services such as cleaning guest rooms, performing marketing efforts, and
operating the concierge desk won't be performed daily, the Company would have to estimate
how much of the $8,000 revenue must be allocated to each of these services if executed on a
given day.
And the new agreement affects only the contract’s price
Because to be provided for the remaining three years of the contract are distinct
Both entities must account for modification prospectively. Meaning this price concession is the
termination of the old contract and the beginning of a new agreement.

If the promised services remain unchanged