1.7 Step 4: Allocate the Transaction Price to the Performance Obligations in the Contract (Chapter 7 of the Roadmap)

Step 4 requires an entity to allocate the transaction price determined in step 3 to the performance obligations identified in step 2 by using the following approaches:

• Allocating the transaction price to the performance obligations on the basis of the stand-alone selling price (see Section 7.2).
• Allocating a discount to one or more, but not all, of the performance obligations in the contract (see Section 7.4).
• Allocating variable consideration to one or more, but not all, of the distinct goods or services in the contract (see Section 7.5).
• Allocating changes in the transaction price to the performance obligations in the contract (see Section 7.6).

Under ASC 606-10-32-32, when a contract contains more than one performance obligation, an entity would generally allocate the transaction price to each performance obligation on a relative stand-alone selling price basis. The guidance states that the “best evidence of a standalone selling price is the observable price of a good or service when the entity sells that good or service separately in similar circumstances and to similar customers.” If the good or service is not sold separately, an entity must estimate the stand-alone selling price by using an approach that maximizes the use of observable inputs. Acceptable estimation methods include, but are not limited to, (1) adjusted market assessment, (2) expected cost plus a margin, and (3) a residual approach (when the stand-alone selling price is not directly observable and is either highly variable or uncertain). An entity would determine the stand-alone selling price for a good or service at contract inception and would not reassess or update its determination of the stand-alone selling price thereafter unless the contract is modified.

The guidance indicates that if certain conditions are met, there are limited exceptions to this general allocation requirement. When those conditions are met, a discount or variable consideration must be allocated to one or more, but not all, of the performance obligations in a contract.

Changes in the transaction price (e.g., changes in an estimate of variable consideration) after contract inception would be allocated to all performance obligations in the contract on the same basis (unless the terms of the contract meet certain criteria that allow for allocation of variable consideration to one or more, but not all, of the performance obligations).

The guidance allows entities to use a residual approach in allocating contract consideration, but only when the stand-alone selling price of a good or service is not directly observable and is either “highly variable or uncertain.” An entity will need to use judgment in determining whether these criteria are met.