How do you account for a contract modification under IFRS 15 / ASC 606?

Question

AcadiFi · Accepted Answer

Contract modifications are testable because the treatment depends on two conditions, and getting it wrong completely changes the revenue recognition pattern.

**The Decision Framework**

When a contract is modified, ask two questions:

1. Does the modification add **distinct goods or services**?
2. Is the additional consideration reflective of the **standalone selling price** of those distinct goods/services?

If BOTH answers are yes → **Separate contract** (new contract, no impact on existing)

If either answer is no → **Modification of existing contract** (two sub-approaches)

**Belmont Construction Analysis**

| Question | Assessment |
|---|---|
| Are the expansion services distinct? | Yes — the expansion can be identified separately from the original warehouse |
| Is $3M reflective of standalone price? | Need to check — if a standalone expansion would cost $3.5M, the $3M includes a discount, which may suggest it's NOT at standalone price |

**Scenario A: Separate Contract ($3M = standalone price)**

The expansion is treated as a brand new contract:
- Original contract: continue recognizing the $10M over remaining performance
- New contract: recognize $3M over the expansion work
- No adjustment to revenue already recognized

**Scenario B: Modification of Existing Contract**

If the $3M is NOT at standalone price (includes a discount for the existing relationship), the modification is folded into the original contract. Two sub-approaches:

**B1: Prospective approach** (remaining goods/services are distinct from those already transferred)
- Combine remaining transaction price: remaining from original + $3M
- Recognize over remaining performance obligations
- Revenue already recognized is NOT adjusted

**B2: Cumulative catch-up** (remaining goods/services are NOT distinct — part of a single performance obligation)
- Recalculate total transaction price: $10M + $3M = $13M
- Recalculate percentage of completion
- Adjust revenue to date with a cumulative catch-up in the current period

```mermaid
flowchart TD
    A["Contract Modified"] --> B{"Distinct goods/services
AND standalone price?"}
    B -->|Both Yes| C["Separate Contract
No impact on original"]
    B -->|Either No| D{"Remaining goods distinct
from already transferred?"}
    D -->|Yes| E["Prospective:
Adjust remaining revenue"]
    D -->|No| F["Cumulative Catch-Up:
Recompute % complete"]
```

**Belmont Example — Cumulative Catch-Up**

Assume the warehouse construction is a single performance obligation (continuous transfer of control). At modification date, Belmont is 50% complete.

Before modification:
- Revenue recognized to date: 50% x $10M = $5M
- Costs incurred to date: $4M

After modification (total contract = $13M, estimated total costs = $9.1M):
- New % complete = $4M / $9.1M = 43.96%
- Revenue that should have been recognized = 43.96% x $13M = $5.71M
- Revenue already recognized = $5M
- **Catch-up adjustment = $0.71M** recognized in the current period

**Exam tip:** The most common exam format gives you a modification scenario and asks which approach to use. The key determinant is whether the additional goods/services are distinct AND priced at standalone selling price.

For more contract modification practice, explore our CFA Level II FRA community.

How do you account for a contract modification under IFRS 15 / ASC 606?

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Related Questions

Practice Questions

Question	Assessment
Are the expansion services distinct?	Yes — the expansion can be identified separately from the original warehouse
Is $3M reflective of standalone price?	Need to check — if a standalone expansion would cost $3.5M, the $3M includes a discount, which may suggest it's NOT at standalone price