Under the revenue recognition framework ASC 606, a material right exists when a customer has the option to buy additional goods or services at a discount or on terms that are not available to others. If this option provides a genuine incentive to the customer and is something they wouldn’t get without the original contract, it counts as a separate performance obligation. In these cases, part of the revenue from the original sale must be set aside and only recognised when the customer uses the option or when it expires.

This concept is particularly relevant for businesses that rely on customer incentives to drive sales, whether through loyalty programmes, discounts on future purchases, or bundled offerings. Loyalty points or discounts on future buys can create a material right, which means that – under Accounting Standards Codification (ASC) 606 – the business has to defer some of the revenue until those points or discounts are used.

Below, we’ll cover what’s considered a material right, how to recognise revenue when a material right exists, and challenges that can arise in material right accounting.

What’s in this article?

• What is a material right?
  
• How to identify material rights in customer agreements
  
• How to recognise revenue when a material right exists
  
• Challenges in material right accounting
  

What is a material right?

Under ASC 606, a material right is an option included in a contract that gives a customer a benefit they wouldn’t otherwise receive, such as a discount on future purchases or access to exclusive offers. To be considered a material right, it must create an incentive for the customer to enter into or stay in the contract, and it must provide something beyond what a typical customer would get without the initial transaction. A material right represents a separate performance obligation in the contract because it provides additional value that affects future transactions between the business and the customer.

Material rights differ from other contract elements such as standard discounts, coupons, or promotional offers available to everyone. Standard discounts or price adjustments reduce the transaction price of a current sale, but they do not extend to future sales or provide a special benefit tied to a specific customer contract. For example, a 10% discount available to all new customers when signing up for a service does not constitute a material right because it doesn’t provide a unique benefit that could only be obtained by entering into the current transaction. In contrast, a “buy one, get one 50% off” deal tied to a loyalty membership or a contract-specific reward programme might qualify as a material right if it creates an expectation of additional value beyond the initial sale.

Identifying material rights in customer agreements involves assessing the terms and conditions to determine if they provide additional benefits tied to future transactions. In loyalty programmes, for instance, points or rewards that can be redeemed for discounts or free products in the future often create material rights. Similarly, a discount on future purchases included as part of a current contract (e.g., “20% off your next purchase”) could also be considered a material right if the discount is not otherwise available.

How to identify material rights in customer agreements

The key distinction for a material right is that it gives the customer a benefit they wouldn’t gain without the contract. Here’s what to consider when identifying these rights.

• The nature of the customer option: Look closely at any options offered to the customer. These might be discounts, loyalty points, vouchers, or special access to future products or services. Determine whether these options provide a benefit that is distinct from the usual terms available to the public. For example, a loyalty programme that allows customers to accumulate points is a material right if earning a certain number of points leads to a discount or free product.

• Economic impact and customer behaviour: A material right is defined by the economic value it provides and how it changes customer behaviour. Consider whether the option is designed to affect the customer’s likelihood of future transactions. If a discount or reward is meant to drive repeat business or alter purchasing patterns, it’s likely a material right.

• Exclusivity and rarity: Determine whether the option is exclusive to a contract or customer segment. A broad-based discount that anyone can use doesn’t create a unique value proposition and isn’t a material right. But a discount or benefit that’s only available to customers who have made a certain purchase or joined a loyalty programme likely is. The more custom and exclusive the option is, the more likely it’s a material right.

• Financial substance: Consider the stand-alone selling price of the option. If a future discount or benefit has real economic value on its own, that’s a strong indicator of a material right. The challenge here is to estimate the expected benefit on not just face-value calculation, but also on probable customer behaviour.

• New data: Material rights are not static. They can change as customer behaviour, market conditions, or contractual terms evolve. Monitor new contract terms, shifts in how customers use loyalty programmes, and other data that could affect the status of what constitutes a material right. Continuing to reassess can help ensure your revenue recognition remains accurate and responsive to real-world changes.

How to recognise revenue when a material right exists

Material rights are considered separate performance obligations within contracts, which affects how revenue is recognised. Here’s how to apply the five-step model to these types of contracts.

Identify the contract with a customer

Evaluate the agreement to determine if it meets the criteria for a contract under ASC 606. This involves confirming that:

• There is approval and commitment from both parties

• Each party’s rights and payment terms are identifiable

• The contract has commercial substance

• It is probable that the entity will collect the payment to which it will be entitled

For contracts with material rights, make sure the option (e.g., loyalty points, future discounts) is clearly outlined in the contract and determine whether it’s tied to a valid, enforceable agreement.

Identify the performance obligations in the contract

Break down the contract to identify all distinct performance obligations or promises to transfer a good or service to the customer. In contracts with material rights, this includes both the initial goods or services sold and the material right itself. A material right must be evaluated separately because it provides a benefit not available to other customers, making it a distinct obligation.

For example, if a customer buys a product and earns points that can be redeemed for future discounts, both the sale of the product and the option to redeem points are performance obligations.

Determine the transaction price

Calculate the total payment expected for fulfilling the performance obligations. This includes fixed amounts, variable considerations, and any discounts or incentives tied to the contract. For contracts with material rights, estimate the value of the material right. The transaction price should reflect the stand-alone selling price of the initial goods or services and the expected value of the future option (material right). This estimation should take into account customer usage patterns and redemption rates.

For example, if a customer is likely to use a 20% discount on a future purchase, you would estimate the transaction price by factoring in the likelihood and expected value of that future discount.

Allocate the transaction price to the performance obligations

Allocate the transaction price to each performance obligation based on their relative stand-alone selling prices. Estimate the stand-alone selling price of the material right using methods such as the adjusted market assessment approach, expected cost plus margin approach, or residual approach. The allocated transaction price determines how much revenue will be recognised for each performance obligation.

For instance, if a customer pays $100 for a product and earns a future discount valued at $10, the $100 would be allocated proportionally between the product and the discount (material right). This affects how revenue is recognized over time.

Recognise revenue when (or as) each performance obligation is satisfied

Revenue must be recognised as each performance obligation is fulfilled. For the initial sale, revenue is recognised when control transfers to the customer. For the material right, revenue is recognised either when the customer exercises the option (e.g., redeems loyalty points, uses a discount) or when the option expires. Align revenue recognition with the actual delivery of value to the customer.

If a customer earns loyalty points on a purchase that can be redeemed for a discount on a new purchase, those loyalty points are a material right. When the customer redeems that discount, the revenue associated with that material right is recognised. If the points expire, the revenue associated with the unexercised option is recognised then.

Challenges in material right accounting

Accounting for material rights under ASC 606 can be an involved process. Here’s some guidance on how to work through common issues.

• Stand-alone selling prices: Businesses that handle material rights must calculate what they are worth on their own (i.e., their stand-alone selling price). Unlike regular products, these options don’t have a clear market price. Businesses must determine a stand-alone price that reflects what a customer might reasonably pay for that future benefit if it were sold on its own. This involves examining factors such as historical redemption rates, customer behaviour trends, and competitive offers in the market. It’s a nuanced process; if the business estimates too low, it understates the deferred revenue. If it estimates too high, it could end up deferring more than it should.

• Customer usage: Businesses must predict how customers will use these rights by making an educated guess about future behaviour. They’ll need to consider what percentage of customers will actually redeem their points or use that discount, and whether changes in the economy or customer preferences might affect those rates. Monitor and adjust this prediction over time as new data becomes available. You’ll need to make good estimates and also build a useful process that adapts as conditions change.

• Financing components: Businesses must consider the impact of financing components in material rights. If a customer pays today for a future benefit, a substantial delay between payment and delivery could imply an interest cost. This means the amount of revenue recognised will differ from the amount received from the customer. This isn’t just an accounting technicality – it can affect a business’s margins, financial ratios, and cash flow.

• Contract costs: Businesses must manage contract costs tied to future rights. If a business runs a loyalty programme that gives customers discounts on future purchases, it must track the costs of fulfilling those discounts and match them to the revenue recognised when the points are redeemed or expire. These costs aren’t always straightforward and can spread over multiple periods, which makes expense recognition even more difficult. Managing these costs requires a comprehensive system to track and match these moving pieces.

• Customer behaviour and market conditions: Even the best models can be disrupted by shifts in customer behaviour or sudden changes in market conditions. A loyalty programme might perform well in one year and fall flat in the next if customers lose interest or competitors offer better deals. Businesses must constantly refine their accounting estimates based on fresh data and changing conditions – and be prepared to adapt. Failure to adjust can mean both misreported revenue and missing out on strategic insights into customer loyalty and future sales trends.

• Multi-element contracts: When contracts involve multiple goods, services, and material rights bundled together, businesses must identify, value, and appropriately allocate each element. These elements can be interdependent and might have different revenue recognition patterns, which can create further challenges. Businesses must ensure their accounting reflects the economic substance of each component and its impact on the overall deal.

• Policies and controls: Businesses need strong internal controls and flexible revenue recognition policies to manage these challenges. They’ll need systems that can handle complex calculations, data analytics to monitor customer behaviour in real time, and governance processes that allow for regular review and adjustment. Some businesses might need to invest in better technology and more specialised expertise to meet these demands.