Question

Explain the accounting for contract modifications.

Short answer

If the modification results in creating a new performance requirement, that performance obligation should be monitored independently.

Step-by-step solution

Meaning of Contract Modification

A contract modification refers to a modification, change, or alteration in the scope or price (or both) of a contract that adds new rights or duties or alters existing ones.

Accounting for contract modification

If a contract modification occurs as a result of a change in an entity's contract with a customer, the products and services and their selling prices must be evaluated. Depending on whether such commodities and services are separate or supplied at their stand-alone selling pricing, a change can be accounted for as follows:

There is a separate contract.

• If the amendment is not accounted for as a distinct contract, one of the following options:
• The previous contract will be terminated, and a new contract will be created (with no adjustment to the historical accounting).
• The amendment was paired with a cumulative catch-up adjustment to revenue under the original contract.
• The economics of the transaction are accurately reflected by a combination of the two sub-bullet points above.