Costs to Fulfill a Contract in ASC 606

When the FASB created ASC 606, it also added a new subtopic on cost capitalization in contracts with customers, which can be found in ASC 340-40. This subtopic guides incremental costs and contract fulfillment costs. Incremental costs are costs that would not have been incurred if the contract had not been obtained (e.g., sales commission). Contract fulfillment costs are costs required for completing a contract (e.g., direct labor, costs explicitly chargeable to a customer). This article focuses only on contract fulfillment costs. For more information on incremental costs, refer to Incremental Costs of Obtaining a Contract.

Companies incur many different costs when fulfilling contracts with customers. These costs include the purchase or development of inventory, software, intangible assets, and other property and equipment. ASC 340-40 provides general guidelines for capitalizing fulfillment costs, including direct labor, direct material, and costs explicitly chargeable to a customer. It also provides guidance on amortizing these capitalized fulfillment costs.

Considerations in Accounting for Costs to Fulfill a Contract

ASC 340-40 requires entities to assess whether contract fulfillment costs incurred fall within the scope of other applicable guidance, such as that for inventory, property and equipment, or software development. When such guidance already exists, companies must follow that guidance. Costs that are not within the scope of other guidance should be capitalized if they meet all the following criteria (ASC 340-40-25-5):

The cost relates directly to an existing contract or a specific anticipated contract (such as an anticipated contract renewal).
The cost generates or enhances resources of the company that will be used to satisfy performance obligations in the future. For example, engineering and design costs incurred to build a server to store customer data would be capitalized. In contrast, systematically assigned overhead costs do not generate or enhance resources for fulfilling performance obligations and thus would not be capitalized.
The company expects to recover the cost. The cost is recoverable if it is explicitly reimbursable under the contract or if the transaction price includes the cost.

The following costs should be expensed when incurred (ASC 340-40-25-8):

General and administrative costs not explicitly chargeable to the customer.
Costs of wasted resources, such as labor and material to fulfill a contract, that are not reflected in the contract price.
Costs that relate to past performance in the contracts (i.e., costs related to a satisfied or partially satisfied contract).
Costs for which an entity cannot determine whether the costs relate to unsatisfied, satisfied, or partially satisfied performance obligations

An entity should not defer costs solely to align its recognition with related revenue. This principle applies even when the associated revenue includes constrained variable consideration.

Amortization of Contract Costs

A company should amortize capitalized contract fulfillment costs on a systematic basis that reflects the pattern of transfer of the related goods or services. These goods or services may extend beyond the current contract to include specifically anticipated future contracts. For example, a data storage company with a three-year contract that expects the customer to renew for an additional three years would amortize related fulfillment costs (e.g., data storage design costs) over the full six-year period.

If the expected timing of transferring goods or services changes significantly (e.g., the goods are transferred in two years instead of the original estimate of five years), the company should revise the amortization amount to reflect the change on a current prospective basis in accordance with ASC 250, Accounting Changes and Error Corrections.

Companies should note that under ASC 340-40 and ASC 606, the amortization pattern for contract fulfillment costs does not have to match the revenue recognition pattern for nonrefundable upfront fees. This is true even when contract fulfillment costs and nonrefundable upfront fees are deferred in the same contract.

Example A: Different Guidance for Different Costs

Company A signs a contract to store a customer’s data for six years, and it expects the customer to renew the contract for two more years when the original contract expires. In order to fulfill the contract, the Company is designing a new platform to store the customer’s data, which includes a server and software for internal use. The Company also incurs costs to implement the platform. Additionally, Company A systematically allocates some of its general and administrative costs to the contract. Although the customer does not receive control of the platform, the cost of the platform is reflected in the contract transaction price. The following are the costs that Company A incurs to set up the storage center:

Hardware Cost……………….. $50,000

Software Cost……….…………$30,000

Design Cost…………..………. $40,000

Implementation Cost…………..$35,000

Allocated G&A Costs…………. $20,000

In this example, the hardware cost is accounted for in accordance with ASC 360, while the software cost is accounted for under ASC 350-40, Internal-Use Software. According to ASC 340-40, the design and implementation costs are capitalized because

they relate directly to the six-year contract and the anticipated two-year contract;
they generate a resource (the platform) that will be used to fulfill the contract and the anticipated contract;
they are expected to be recovered as they are reflected in the six-year contract transaction price.

Company A should amortize the design and implementation costs over eight years (the original contract and the specific anticipated contract). On the other hand, the G&A cost allocated to the contract should be expensed as incurred because it does not generate or enhance a resource.

Example B: Reworking Cost

Manufacturer B obtains a contract to produce highly customized car frames for a customer for eight years. Due to the highly customized nature of the product, Manufacturer B could not sell the car frames to another customer without incurring a high cost. Should the customer terminate the contract early, the Manufacturer can receive payment for all the work completed up to the termination date. Manufacturer B expects to incur a significant amount of reworking costs during the earlier years of the contract, and less as time goes on. How should Manufacturer B account for the reworking cost (assuming that the contract’s performance obligation is satisfied over time)?

This contract includes a single performance obligation—the provision of highly customized car frames—which is satisfied over time. Therefore, the reworking cost should be capitalized. The amortization recognized in a particular year during the contract will depend on the method that the manufacturer chooses to recognize revenue over time (most likely the cost-to-cost method).

Astronics Corporation Correspondence with the SEC on Capitalization of Costs

add

Astronics Corporation is an aerospace electronics corporation known for its innovative technology solutions, which include lighting and electronics integrations and semiconductor test systems. In an October 2018 SEC comment letter, Astronics responded to an inquiry from the SEC regarding its capitalization of costs. Astronics explained:

Following the adoption of ASC 606, the Company considered the guidance set forth in ASC 340-40, and determined that these costs represent costs to fulfill a contract under ASC 340-40-25-5… The pre-contract costs capitalized and disclosed in Note 1 represent the capitalization of certain costs to fulfill a contract. The capitalized pre-contract costs (fulfillment costs) relate to goods that will be transferred under multiple contracts (the purchase orders) and will be amortized over a period that is consistent with the transfer to the customer of the goods to which the asset relates.

Astronics’ response reflects a disciplined application of ASC 340-40 by first evaluating whether the costs fall within other applicable guidance and then appropriately identifying them as contract fulfillment costs under ASC 340-40-25-5. The key judgment lies in linking the pre-contract costs to future performance obligations across multiple purchase orders, which supports capitalization rather than immediately expensing. By amortizing these costs over a period consistent with the transfer of the related goods, Astronics aligns expense recognition with the pattern of benefit, consistent with the objective of ASC 606. Importantly, this approach also demonstrates that pre-contract costs can be capitalized when they are directly related to anticipated contracts and are expected to be recovered, rather than being dismissed solely because they are incurred prior to contract execution.

Paychex, Inc. (Form 10-K, 2020): Paychex Recognition of Assets

add

Paychex, Inc. provides integrated human capital management solutions for small- and medium-sized businesses, including payroll, benefits, human resources, and insurance services. Paychex’s 2020 10-K explains how the company accounts for costs to fulfill contracts:

The Company also recognizes an asset for the costs to fulfill a contract with a client if the costs are specifically identifiable, generate or enhance resources used to satisfy future performance obligations, and are expected to be recovered. The Company determined that substantially all costs related to implementation activities are administrative in nature and meet the capitalization criteria under ASC 340-40. These capitalized costs to fulfill a contract principally relate to upfront direct costs that are expected to be recovered and enhance the Company’s ability to satisfy future performance obligations.

The assets related to both costs to obtain and costs to fulfill contracts with clients are capitalized and amortized using an accelerated method over an eight-year life to closely align with the pattern of client attrition over the estimated life of the client relationship. The Company regularly reviews its deferred costs for potential impairment and did not recognize an impairment loss during the fiscal years ended May 31, 2019, or May 31, 2020.

Waitr Holdings Inc. (Form 10-K, 2020): Waitr Holdings' Treatment of Costs to Fulfill a Contract with a Customer

add

Louisiana-based Waitr Holdings Inc. provides a restaurant platform for online food ordering and delivery services throughout the United States. Waitr connects local restaurants to customers in underserved U.S. markets. The company’s 2020 10-K provides an example of capitalizing and amortizing set-up costs (see Note 2):

The Company also recognizes an asset for the costs to fulfill a contract with a restaurant when they are specifically identifiable, generate or enhance resources used to satisfy future performance obligations, and are expected to be recovered. The Company has determined that certain costs related to menu and other setup and integration activities meet the capitalization criteria under ASC Topic 340-40, Other Assets and Deferred Costs. Costs related to these implementation activities are deferred and then amortized to operations and support expense on a straight-line basis over the period of benefit.

As a result of changes to contract terms associated with the revised fee structure introduced in July 2019, the Company reassessed the useful life of its contract fulfillment cost assets to better reflect the period over which the assets are expected to provide benefit. Effective August 1, 2019, the estimated useful life was extended from two years to five years.

Impairment of Contract Costs

Impairment tests should be performed at the end of each reporting period and in the occurrence of an event that may indicate the asset’s carrying amount is no longer recoverable. To test for impairment, a company should focus on whether the capitalized contract fulfillment cost is recoverable. If the carrying amount of capitalized costs exceeds the sum of (1) the consideration the entity expects to receive in the future and (2) any consideration already received but not yet recognized as revenue, less the direct costs of providing the remaining goods or services (e.g., direct labor and direct materials) that have not yet been recognized as expenses, the excess should be recognized in profit or loss.

The company should use the principles for determining transaction price in Step 3 of the Revenue Recognition Model when calculating expected consideration for the impairment test. However, if the transaction price would normally have been reduced due to the constraint on variable consideration, the unconstrained amount should be used for impairment testing purposes. In addition, that price must be reduced to reflect the customer’s credit risk for impairment testing purposes.

Before recognizing an impairment loss under ASC 340-40, the company should consider whether impairment losses should be recognized in accordance with other applicable guidance, such as ASC 360, Property, Plant, and Equipment, and ASC 350, Intangibles—Goodwill and Other. Once impairment losses are recognized, the company may not reverse such losses, even when the reasons for the impairment no longer exist.

Conclusion

ASC 340-40 provides guidance for capitalizing some contract fulfillment costs. Companies should first assess whether the cost in question is covered by other guidance. When not covered by other guidance, contract fulfillment costs should be capitalized under ASC 340-40 if they meet three criteria: (1) the cost is directly related to a current or a specific anticipated contract; (2) the cost generates or enhances a resource that is used to fulfill performance obligations; and (3) the cost is recoverable.

Editor’s Note

This article was reviewed in 2026 for consistency and correctness in accordance with present guidance. This article reflects guidance under ASC 606, Revenue from Contracts with Customers, as currently codified, including subsequent amendments. While originally published in 2022, the concepts discussed remain relevant, as ASC 606 has not undergone substantive changes affecting the topics involved in this article.

Resources Consulted

ASC 340-40-25-5 to 25-8, ASC 340-40-35-1 to 35-6
ASU 2014-09: “Revenue from Contracts with Customers.” BC304-BC316.
EY, Financial Reporting Developments: “Revenue from contracts with customers.” August 2025. Section 9.3.2, Section 9.3.3, Section 9.3.4.
KPMG, Handbook: “Revenue Recognition.” December 2025. Section 12.5, Section 12.6, Section 12.7, Section 12.8, Section 12.9.
PWC, “Revenue from contracts with customers.” September 2025. Section 11.3, Section 11.4