Authoritative guidance provided in ASC 606

Transworld Shippers Inc. (TWS) provides domestic and internationaltransportation and logistics services to customers. The company contractsshipping vessels, trucks, and aircraft to provide regional, long-haul, andinternational shipments of customer goods. TWS prepares its financialstatements in accordance with U.S. GAAP. It adopted ASC Topic 842, Leases, onJanuary 1, 2019.

InMarch 2023, TWS signed a shipping contract with Customer A, in which TWS is theexclusive shipper of A’s products between Shanghai and Los Angeles. TWS’scontract with A is effective on July 1, 2023. Before signing the contract withA, TWS did not operate the Shanghai-Los Angeles route. Further, TWS had noother customers on July 1, 2023, to deliver goods on the Shanghai-Los Angelesroute.

InApril 2023, to satisfy the contract with A, TWS leased a cargo ship fromLessors Inc. The lease agreement commences on July 1, 2023.

Thefollowing are relevant facts about TWS’s shipping contract with Customer A and itslease with Lessors Inc.

Shipping Contract with Customer A

·       Theshipping contract’s stated term with A is for one year.

·       CustomerA can renew the contract annually for up to four additional years. Therefore,the revenue contract can extend to include a total of five years.

·       CustomerA pays a significant up-front nonrefundable fee for the initial one-year term;the same amount is due at the beginning of every renewal period.

·       CustomerA can cancel at any time without incurring a penalty other than forfeiting anyup-front nonrefundable fees already paid or owed at the beginning of theinitial contract term and any nonrefundable fees paid or owed at the beginningof each renewed period.

·       Althoughthe contract is new, TWS and Customer A have entered into similar arrangementswith similar terms and routes, and, historically, A has renewed for one or moreyears.

·       TWSconcludes that (1) the shipping contract with A meets the scope of and criteriain ASC Topic 606, and (2) the contract term for its shipping contract with A isone year.

Lease withLessors Inc.

·       Thecontract between TWS and Lessors contains a lease under ASC Topic 842.

·       Rentalpayments are fixed, aligned to market prices each year.

·       Tomitigate risks, TWS negotiated the lease period and renewal options to mirrorthose of its revenue contract with Customer A. As a result, the fixed,noncancelable term of the lease is one year, and TWS can renew annually forfour additional years (i.e., up to five full years).

·       TWSbelieves that since Customer A can terminate the revenue contract after oneyear (even though A may need to ship products for longer than a year and hashistorically renewed under other similarly structured contracts), it isuncertain whether A will renew the revenue contract. Because of thisuncertainty, TWS believes that the renewal options related to the lease are notreasonably certain at the commencement date of the lease. As a result, TWSconcludes that the lease term for its lease contract with Lessors is also oneyear.

CaseRequirements
Consider the terms of the two contracts and the authoritative guidance providedin ASC 606, “Revenue from Contracts with Customers,” and ASC 842, “Leases,"to assess whether TWS has correctly concluded that the lease term with Lessorsis for one year. How should the lease be accounted for in TWS’s 2023 financialstatements? Be sure to identify the key factors and applicable authoritativeguidelines supporting your conclusions.

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