Understanding ASC 340-40: Components, Costs & Considerations

Introduction

When businesses offer products or services, they often incur costs associated with securing and fulfilling customer contracts. These costs can range from sales commissions to expenses tied to contract fulfillment. To ensure accurate accounting of these costs, ASC 340-40 was introduced as part of the U.S. GAAP (Generally Accepted Accounting Principles). This standard outlines how companies should handle costs associated with obtaining and fulfilling contracts, especially under the revenue recognition principles, outlined inASC 606.

By understanding ASC 340-40, businesses can better align their financial reporting with their actual economic activities. This ensures transparency and accuracy in representing contract-related costs, particularly when it comes to commissions and similar expenses.

In this blog, we will explore what ASC 340-40 is, its components and the criteria businesses should keep in mind to ensure compliance with ASC 340-40. 

What is ASC 340-40 ?

ASC 340-40 focuses on capitalizing costs that are directly tied to obtaining and fulfilling contracts, rather than expensing them immediately. This means that costs like sales commissions, directly related to the contract acquisition, should be recorded as an asset and amortized over the contract’s duration.

ASC 340-40, formally known as “Other Assets and Deferred Costs – Contracts with Customers,” provides guidelines for how businesses should treat the costs associated with acquiring and fulfilling contracts. It was developed to align with ASC 606, the standard for revenue recognition, to ensure consistency in cost and revenue recognition . 

In simple terms, ASC 340-40 ensures that companies spread out the recognition of certain costs over the life of a contract instead of recording them all at once, leading to more accurate financial reporting. It helps businesses avoid fluctuations in profit and loss that might occur if significant costs were expensed upfront.

What Are The 3 Main Components Of ASC 340-40

ASC 340-40 focuses on three key components that businesses must consider when accounting for contract-related costs:

• Costs to obtain a contract

These are incremental costs incurred in securing a contract, such as sales commissions. If these costs are directly related to obtaining the contract and expected to be recovered, they should be capitalized as an asset and amortized over the period the related goods or services are transferred to the customer..

• Costs to fulfill a contract

Once a contract is obtained, businesses may incur additional costs to fulfill their performance obligations. These could include materials, labor, or overhead expenses. If these costs generate or enhance resources that will be used in fulfilling future obligations of the contract and are expected to be recovered, they should be capitalized and amortized over the contract term. Otherwise, these costs should be incurred as an expense.

• Amortization and impairment of capitalized costs

After capitalizing the costs, businesses must amortize them systematically over the period the related performance obligations are fulfilled, which may or may not align with the contract duration. Additionally, companies must assess the capitalized costs for impairment and if there is any indication that the asset is no longer recoverable, necessary adjustments should be made to reflect their true worth.

What Are The Different Types Of Cost Under ASC 340-40

ASC 340-40 covers various costs related to obtaining and fulfilling contracts. These costs must meet specific criteria to be capitalized and amortized over time. Proper treatment of these costs ensures compliance and accuracy in financial reporting. Below is a table highlighting the types of costs and how they are treated under ASC 340-40:

This breakdown helps businesses classify their contract-related costs and manage them in accordance with ASC 340-40’s guidelines. Proper treatment of these costs ensures compliance and accuracy in financial reporting.

What Are The Considerations While Implementing ASC 340-40

Implementing ASC 340-40 requires careful planning and evaluation of several factors to ensure compliance and accuracy in financial reporting. Below are key considerations for businesses:

1. Identifying Contract Costs: Businesses must clearly differentiate between costs that should be capitalized and those that must be expensed immediately. Incremental costs directly tied to contract acquisition and those that enhance or generate resources for fulfillment should be capitalized, but general costs like administrative expenses, typically do not qualify.
2. System Adjustments: Companies may need to adjust their accounting systems to track and monitor capitalized costs, their amortization and impairment over the life of a contract. This includes setting up processes for amortization and impairment assessments in compliance with ASC 340-40.
3. Employee Training: Proper implementation often involves training staff to recognize which costs meet the capitalization requirements under ASC 340-40. Sales teams, finance departments, and legal teams all play a key role in identifying contract-related costs that meet the standard’s criteria.
4. Compliance with ASC 606: Since ASC 340-40 is closely tied to the revenue recognition standard (ASC 606), companies must ensure that their methods for recognizing contract costs and revenue are aligned.
5. Impairment Reviews: Regular reviews are necessary to assess whether capitalized costs have lost value. If costs no longer provide the expected economic benefits, impairment losses must be recognized in financial statements.

By addressing these considerations, companies can successfully implement ASC 340-40, maintain compliance with the U.S. GAAP and provide accurate financial reporting.

Challenges in Implementing ASC 340-40

Implementing ASC 340-40 may seem straightforward, but it comes with its own set of challenges that businesses need to address to ensure smooth adoption and compliance. Some of the key challenges include:

1. Identifying capitalized costs: One of the biggest hurdles is correctly identifying which costs should be capitalized versus those that should be expensed immediately. Misclassification can lead to over-or-under capitalization, resulting in financial inaccuracies and potential compliance issues.
2. System overhaul: Many companies may need to upgrade or modify their accounting systems to handle the requirements of ASC 340-40. This can be a time-consuming and costly process, especially for businesses with complex contracts or those not using sophisticated accounting software.
3. Amortization and impairment tracking: Managing the amortization of capitalized costs over a contract’s duration that must align with performance obligations fulfillment, and regularly assessing impairment requires precise tracking. Failure to do so can result in under- or over-reporting financial figures, leading to discrepancies in financial statements.
4. Training and coordination: Implementing ASC 340-40 requires collaboration between multiple departments, including finance, sales, and legal. Ensuring that all teams understand the new guidelines and their roles can be a challenge, particularly for large organizations. Cross-department coordination is imperative for correctly recognizing and tracking capitalized costs.
5. Alignment with ASC 606: Since ASC 340-40 is closely linked to ASC 606 (revenue recognition), ensuring alignment of both standards can be complex. Misalignment can lead to incorrect reporting of both revenue and costs, making compliance more difficult.

How HighRadius Can Facilitate Implementation of ASC 340-40

Implementing ASC 340-40 can be a challenging task, given the complexities of tracking contract-related costs like commissions and fulfillment expenses. HighRadius’ Financial Close Management software offers a comprehensive solution to simplify and streamline this process, ensuring compliance with U.S. GAAP.

HighRadius provides businesses with powerful tools like the Close Checklists, which ensures all contract-related documents, approvals, and comments are organized and audit-ready. This module helps companies track essential contract data and backup documentation, improving productivity and simplifying audit processes by having all necessary information easily accessible.

HighRadius also boosts efficiency with its LiveCube Task Automation, allowing businesses to automate data extraction and roll over critical information with minimal manual input. This reduces human error, enhances speed, and enables teams to focus on essential tasks like contract cost tracking, audit preparation, and financial reporting.

Finally, the Journal Entry Management Software ensures all journal entries related to capitalized costs are recorded with precision. The module logs every action, from preparer to approver, providing a clear audit trail. It also integrates seamlessly with various ERPs, allowing businesses to automate postings while maintaining compliance with ASC 340-40 requirements.

By leveraging HighRadius’ Record to Report Solutions businesses can manage ASC 340-40 implementation more efficiently, ensuring accuracy, compliance, and streamlined financial reporting.

FAQs

1. What does ASC stand for in accounting?

ASC stands for Accounting Standards Codification, a framework used by the Financial Accounting Standards Board (FASB) in the U.S. It organizes all accounting rules and guidelines into a single, comprehensive source for businesses to reference when preparing financial statements in compliance with GAAP.

2. What is the ASC 340 standard?

ASC 340 outlines the accounting treatment for other assets and deferred costs. ASC 340-40 specifically addresses costs incurred to obtain and fulfill contracts with customers, ensuring these costs are capitalized and amortized over the contract’s duration, aligning with ASC 606 on revenue recognition.

3. What type of costs are evaluated for capitalization under ASC 340-40?

ASC 340-40 evaluates costs such as sales commissions, legal fees, fulfillment costs, and setup costs for capitalization. These costs must be directly tied to obtaining or fulfilling a contract, and they are capitalized if they are expected to be recovered over the contract’s term.

4. What are the three criteria for capitalizing cost to fulfill a contract?

To capitalize fulfillment costs under ASC 340-40, the costs must: 

(1) relate directly to the contract, 

(2) generate or enhance resources that will be used to fulfill performance obligations, and 

(3) be expected to be recovered over the duration of the contract.