There are a number of situations in which a buyer may pay a nonrefundable fee to a seller, and in advance of any services or goods being provided by the seller. Examples of these fee arrangements are:
Activation fee. A cell phone customer pays an up-front fee to a telecommunications provider in order to initiate service under an annual phone plan.
Initiation fee. A customer pays an initiation fee to a health club, which also charges an annual or monthly fee in addition to the initiation fee.
Premium web access. A website operator provides premium access to users in exchange for an up-front fee.
Price club membership. A customer pay up-front for the right to shop at a retailer at discounted prices.
In all of the preceding situations, the additional costs incurred by the seller in exchange for the up-front fee are minimal.
In the types of situations just described, the Securities and Exchange Commission (SEC) has stated that there is rarely any specific value obtained by a customer in exchange for an up-front fee. That being the case, such revenue should be recognized on a deferred basis that is linked to the greater of the remaining terms of the arrangement or the period over which the seller expects to perform services for the buyer.
For example, Viking Fitness charges a $500 initiation fee and $700 for one year of membership, which gives members access to its health clubs. Viking should recognize the initiation fees ratably over the initial one year of membership, which means that it can recognize a total of $100 of revenue per month in the first year. One year later, if a member were to renew his membership for an additional $700, Viking should recognize it ratably over the membership period, which would be $58.33 per month for the next 12 months.
If the seller has extended a refund privilege to customers for a up-front fee arrangement, then the seller should not recognize this revenue at all until the period during which the refund offer is available to customers has expired, unless the company can reasonably estimate cancellations on a timely basis from a large pool of homogeneous products, and uses this information to record a reserve for estimated refunds.
For example, Shopper Membership Warehouse charges its members $50 per year to be members of the discount-price buyers club. The deal allows members to obtain a full refund at any time during the membership year. In this case, the company chooses not to recognize any revenue related to the $50 fee until the end of the year, when the refund offer expires. In the meantime, the company should record these annual fees as a liability.
The SEC has indicated that the revenue related to these arrangements should usually be recognized on a straight-line basis, unless there is evidence that revenue is earned in accordance with a different pattern.