How to identify customer contract costs and amortize them
- Graziano Stefanelli
- Sep 18
- 3 min read
Under IFRS 15 and ASC 340-40, costs incurred to obtain or fulfill a customer contract must be capitalized if certain criteria are met, rather than expensed immediately. These standards aim to align the timing of cost recognition with the revenue recognition pattern for the related contract. This treatment enhances financial reporting accuracy, especially for businesses with high customer acquisition costs, such as SaaS providers, telecom firms, and subscription-based platforms.
Costs to obtain a contract must be capitalized if they are incremental and recoverable.
Incremental costs of obtaining a contract are those that:
Would not have been incurred if the contract had not been obtained, and
Are expected to be recovered through future revenue from the contract
Examples:
Sales commissions paid upon securing a contract
Bonuses or incentives tied to contract signing
These must be capitalized and amortized over the period the related goods or services are transferred, unless the amortization period would be one year or less, in which case a practical expedient allows immediate expensing.
Example:
A sales rep earns a $10,000 commission for signing a 2-year service contract.
Dr. Contract cost asset 10,000
Cr. Cash/Payables 10,000
Amortize over 24 months:
Dr. Amortization expense 417
Cr. Contract cost asset 417
Costs to fulfill a contract are capitalized only if they meet specific conditions.
Companies may also incur costs to fulfill a contract that are not within the scope of another standard (e.g., inventory, PPE, intangibles). These fulfillment costs must be capitalized if:
They relate directly to a specific contract
They generate or enhance resources to fulfill performance obligations
They are expected to be recovered
Examples of eligible costs:
Pre-contract engineering or design
Customization or integration efforts
Site preparation for installation
Costs that do not meet these criteria must be expensed.
Amortization should follow the pattern of transferred goods or services.
Capitalized contract costs must be amortized on a systematic basis that reflects the transfer of related goods or services to the customer.
Key factors:
Use the same period and recognition pattern as the associated revenue
Periodically assess for impairment if the expected future benefit changes
If a contract is canceled or modified, the amortization period must be updated accordingly.
Impairment testing must be performed regularly for contract cost assets.
Under both IFRS and US GAAP, capitalized contract cost assets must be assessed for impairment if:
Circumstances change such that recovery is no longer expected
The asset’s carrying amount exceeds the remaining amount of consideration (less costs) expected to be received
Impairment loss is recognized in profit or loss:
Dr. Impairment loss XX
Cr. Contract cost asset XX
If impairment indicators no longer exist in future periods, the asset is not revalued upward.
Disclosure is required for contract cost assets and amortization practices.
Entities must disclose:
The closing balance of capitalized contract costs
Amortization expense recognized during the period
Method and period of amortization
Impairment losses, if any
Whether the one-year practical expedient has been applied
These disclosures typically appear in the notes to financial statements under the revenue or contract-related sections.
Practical expedients allow simplification for short-term contracts.
If the amortization period is 12 months or less, companies may expense costs immediately instead of capitalizing them. This practical expedient avoids unnecessary complexity for short-term or renewable contracts and is widely used in practice.
Contract cost accounting under IFRS 15 and ASC 340-40 is essential for matching revenue with related acquisition and fulfillment efforts. By capitalizing and systematically amortizing these costs, companies present a clearer financial picture, reduce volatility in earnings, and adhere to the economic substance of long-term service and subscription contracts.
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