Contract term

What is a contract term?

A contract term is how long an agreement runs before it must be renewed, such as one or three years. Many service agreements roll into a new term automatically. Under U.S. revenue accounting (ASC 606), the term is the period in which both parties have present enforceable rights and obligations, so a contract the customer can cancel without a substantive penalty counts as shorter than its stated length.

Why it matters to a revenue leader

Longer terms lock in revenue, reduce renewal risk and raise the value of the agreement base to buyers and lenders. They also lock in price, so a long term without an escalator can lose margin each year. For a revenue leader, the stated term and the enforceable term can differ. PwC's guidance gives the example of a three-year services contract either party can end at any month-end without penalty, which is treated as month-to-month. That difference shows up in backlog and remaining performance obligations.

A facility services company offers a one-year maintenance agreement at list price, or a three-year term at 5% off with a 3% annual escalator and a termination fee in the first year. The customer takes the three-year term. The company gains two more years of expected revenue, and the termination fee makes at least the first year enforceable for accounting.