Chapter 7 — Step 4: Allocate the Transaction Price to the Performance Obligations

7.3 Determine the Stand-Alone Selling Price

ASC 606-10

32-31 To allocate the transaction price to each performance obligation on a relative standalone selling price basis, an entity shall determine the standalone selling price at contract inception of the distinct good or service underlying each performance obligation in the contract and allocate the transaction price in proportion to those standalone selling prices.

The stand-alone selling price may be, but is not presumed to be, the contract price. The best evidence of the stand-alone selling price is an observable price for selling the same good or service separately to a similar customer. If a 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) the adjusted market assessment approach, (2) the expected cost plus margin approach, and (3) the residual approach (when the stand-alone selling price is not directly observable and is either highly variable or uncertain).

7.3.1 Observable Stand-Alone Selling Prices

ASC 606-10

32-32 The standalone selling price is the price at which an entity would sell a promised good or service separately to a customer. 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. A contractually stated price or a list price for a good or service may be (but shall not be presumed to be) the standalone selling price of that good or service.

7.3.2 Estimating Stand-Alone Selling Prices

ASC 606-10

32-33 If a standalone selling price is not directly observable, an entity shall estimate the standalone selling price at an amount that would result in the allocation of the transaction price meeting the allocation objective in paragraph 606-10-32-28. When estimating a standalone selling price, an entity shall consider all information (including market conditions, entity-specific factors, and information about the customer or class of customer) that is reasonably available to the entity. In doing so, an entity shall maximize the use of observable inputs and apply estimation methods consistently in similar circumstances.

32-34 Suitable methods for estimating the standalone selling price of a good or service include, but are not limited to, the following:

Adjusted market assessment approach — An entity could evaluate the market in which it sells goods or services and estimate the price that a customer in that market would be willing to pay for those goods or services. That approach also might include referring to prices from the entity’s competitors for similar goods or services and adjusting those prices as necessary to reflect the entity’s costs and margins.
Expected cost plus a margin approach — An entity could forecast its expected costs of satisfying a performance obligation and then add an appropriate margin for that good or service.
Residual approach — An entity may estimate the standalone selling price by reference to the total transaction price less the sum of the observable standalone selling prices of other goods or services promised in the contract. However, an entity may use a residual approach to estimate, in accordance with paragraph 606-10-32-33, the standalone selling price of a good or service only if one of the following criteria is met:
1. The entity sells the same good or service to different customers (at or near the same time) for a broad range of amounts (that is, the selling price is highly variable because a representative standalone selling price is not discernible from past transactions or other observable evidence).
2. The entity has not yet established a price for that good or service, and the good or service has not previously been sold on a standalone basis (that is, the selling price is uncertain).

32-35 A combination of methods may need to be used to estimate the standalone selling prices of the goods or services promised in the contract if two or more of those goods or services have highly variable or uncertain standalone selling prices. For example, an entity may use a residual approach to estimate the aggregate standalone selling price for those promised goods or services with highly variable or uncertain standalone selling prices and then use another method to estimate the standalone selling prices of the individual goods or services relative to that estimated aggregate standalone selling price determined by the residual approach. When an entity uses a combination of methods to estimate the standalone selling price of each promised good or service in the contract, the entity shall evaluate whether allocating the transaction price at those estimated standalone selling prices would be consistent with the allocation objective in paragraph 606-10-32-28 and the guidance on estimating standalone selling prices in paragraph 606-10-32-33.

Stand-alone selling prices must be estimated if, and only if, they are not directly observable. Although ASC 606 does not prescribe a specific approach for estimating stand-alone selling prices that are not directly observable, an entity is required to use an approach that maximizes the use of observable inputs and faithfully depicts the selling price of the promised goods or services if the entity sold those goods or services separately to a similar customer in similar circumstances. The selected method should be used consistently to estimate the stand-alone selling price of goods and services that have similar characteristics. In addition, an entity should consider all information that is reasonably available in determining a stand-alone selling price.

Under ASC 606-10-32-34(c), the residual approach may be used if (1) there are observable stand-alone selling prices for one or more of the performance obligations and (2) one of the two criteria in ASC 606-10-32-34(c)(1) and (2) is met. In addition, even when the criteria for using the residual approach are met, the resulting allocation would need to be consistent with the overall allocation objective. That is, if the residual approach results in either a stand-alone selling price that is not within a range of reasonable stand-alone selling prices or an outcome that is not aligned with the entity’s observable evidence, use of the residual approach would not be appropriate regardless of whether the criteria in ASC 606-10-32-34(c) are met. For example, since a performance obligation, by definition, has value on a stand-alone basis, the stand-alone selling price of a performance obligation cannot be zero. An entity should use all available information to determine the stand-alone selling price, which may include an assessment of market conditions adjusted for entity-specific factors. When such an analysis results in a highly variable or broad range and the residual approach is used to estimate the stand-alone selling price, this observable information should still be used to support the reasonableness of the resulting residual amount.

As discussed in paragraph BC272 of ASU 2014-09, the residual approach under the revenue standard can be used if two or more performance obligations have highly variable or uncertain stand-alone selling prices when they are bundled with other performance obligations that have observable stand-alone selling prices. For example, an entity may enter into a contract to sell a customer two separate software licenses along with professional services and PCS (which are each distinct). The entity may have observable stand-alone selling prices for both the professional services and the PCS, but the stand-alone selling prices of the licenses may be highly variable or uncertain. In such a scenario, the entity might use the residual approach to determine the amount of the transaction price that should be allocated to the two licenses in aggregate and then use another method to further allocate the residual transaction price to each license. When estimating the amount to be allocated to each performance obligation in this way, an entity should consider the guidance in ASC 606-10-32-28 on the objective of allocating the transaction price and the guidance in ASC 606-10-32-33 on estimating stand-alone selling prices.

7.3.3 Examples of Determining the Stand-Alone Selling Price

7.3.3.1 Stand-Alone Selling Price of Postcontract Support Based on a Stated Renewal Percentage

It is common for software contracts to include both a software license and PCS for a defined term. After the initial PCS term, such contracts will often allow for renewal of PCS at a stated percentage of the contractual license fee (e.g., 20 percent of the initial contractual license fee). Contractual license fees will often vary between customers; consequently, the renewal price for the related PCS also often varies between customers.

ASC 606-10-32-32 states, in part, 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” and that the “contractually stated price or a list price for a good or service may be (but shall not be presumed to be) the standalone selling price of that good or service.” Further, ASC 606-10-32-33 requires entities to estimate the stand-alone selling price when that price is not observable.

Because the actual amount paid for the PCS in the software arrangements described above varies between contracts, it may not represent the “observable price” for the PCS when an entity sells the PCS separately “in similar circumstances and to similar customers.” Since the prices vary by individual contract, the contractually stated renewal rate may not necessarily represent the stand-alone selling price for the PCS, especially when PCS is renewed for a broad range of amounts.

If an entity determines that it does not have observable pricing of PCS based on consistent renewal of PCS priced at consistent dollar amounts, it may be appropriate for the entity to consider PCS renewals stated as a constant percentage of the license fee to determine an observable stand-alone selling price for PCS. This approach may be appropriate when the entity routinely prices PCS as a consistent percentage of the license fee, the entity has consistent pricing practices, and the resulting stand-alone selling price results in an allocation that is consistent with the overall allocation objective.

However, when an entity determines that an observable stand-alone selling price for the PCS does not exist, the entity may need to estimate the stand-alone selling price of the PCS in accordance with ASC 606-10-32-33 through 32-35 by considering all of the information that is reasonably available to the entity, such as the actual amounts charged for renewals, the anticipated cost of providing the PCS, internal pricing guidelines, and third-party prices for similar PCS (if relevant). While the range of amounts charged for actual renewals on the basis of the stated rates may be broad (whether priced as a fixed dollar amount or as a percentage of the license fee), a concentration of those amounts around a particular price may help support a stand-alone selling price.

Refer to Section 7.3.3.6 for additional information about using a range to estimate a stand-alone selling price.

7.3.3.2 Residual Approach to Estimating Stand-Alone Selling Prices

In the software industry, certain goods or services can be sold for a wide range of prices. This is especially true when the incremental costs incurred to sell additional software licenses are often minimal, thus allowing entities to sell their software at a wide range of discount prices or even premiums. Various factors may make it challenging for an entity to determine the stand-alone selling prices of goods and services promised in a contract with a customer. Such factors may include, but are not limited to, (1) highly variable or uncertain pricing, (2) lack of stand-alone sales for one or more goods or services, and (3) pricing interdependencies such that the selling price of one good or service is used to determine the selling price of another good or service in the same contract. In these instances, it may be appropriate to estimate the stand-alone selling price of a good or service (or bundle of goods or services) by using the residual approach.

7.3.3.2.1 Appropriateness of Using the Residual Approach

ASC 606-10-32-34(c) indicates that the residual approach may be used only if the selling price of a good or service (or bundle of goods or services) meets either of the following conditions:

The selling price is highly variable. This is the case when an “entity sells the same good or service to different customers (at or near the same time) for a broad range of amounts” so that a single-point estimate of the stand-alone selling price or even a sufficiently narrow range of values representing the stand-alone selling price is “not discernible from past transactions or other observable evidence.” For example, the selling price of a software product may be highly variable if an entity has historically sold the software product for prices between $1,000 and $20,000 and there is no discernible concentration around a single price, range of prices, or other metric.
The selling price is uncertain. This is the case when an “entity has not yet established a price for [a] good or service, and the good or service has not previously been sold on a standalone basis.”

In determining whether one of the above conditions is met, an entity should disaggregate (i.e., stratify) its selling prices into different populations to the extent that pricing practices differ for each population. In doing so, the entity should take into account market conditions, entity-specific factors, and information about the customer or class of customer (e.g., by product, by geography, by customer size, by distribution channel, or by contract value). However, the entity should also consider whether there are enough data points (e.g., a sufficient number of sales in the population) for it to determine a meaningful stand-alone selling price.

In addition to assessing whether one of the two pricing conditions above has been met, an entity must determine whether the resulting amount allocated to a performance obligation under the residual approach satisfies the allocation objective in ASC 606-10-32-28 (i.e., an allocation that depicts the amount of consideration to which an entity expects to be entitled in exchange for a good or service). If the application of the residual approach to a particular contract results in either a stand-alone selling price that is not within a range of reasonable stand-alone selling prices or an outcome that is not aligned with the entity’s observable evidence, use of the residual approach would not be appropriate even if one of the conditions in ASC 606-10-32-34(c) is met. An entity should use all available information to determine whether the stand-alone selling price is reasonable, which may include an assessment of market conditions adjusted for entity-specific factors. When such an analysis results in a highly variable or broad range and the residual approach is used to estimate the stand-alone selling price, this observable information should still be used to support the reasonableness of the resulting residual amount. In addition, the resulting stand-alone selling price must be substantive and consistent with the entity’s normal pricing practices. Further, as paragraph BC273 of ASU 2014-09 states, “if the residual approach in paragraph 606-10-32-34(c) results in no, or very little, consideration being allocated to a good or service or a bundle of goods or services, the entity should consider whether that estimate is appropriate in those circumstances.”

The residual approach is applied by subtracting observable stand-alone selling prices from the total transaction price and allocating the remainder (i.e., the residual) to the performance obligation or obligations for which pricing is highly variable or uncertain (see Example 7-4 for an illustration of this concept). Accordingly, for an entity to apply the residual approach to a contract containing performance obligations whose pricing is highly variable or uncertain, that contract must include at least one performance obligation for which the stand-alone selling price is observable. If a contract contains multiple performance obligations with pricing that is highly variable or uncertain, a combination of approaches (including the residual approach) may be necessary as described in ASC 606-10-32-35.

ASC 606 requires entities to maximize the use of observable data in determining a stand-alone selling price. The observable data available for a good or service may change over time. In addition, an entity’s pricing practices may change as a result of market or entity-specific factors. Therefore, the appropriateness of the residual approach for a particular good or service may also change from one period to another. For example, an entity may implement pricing policies that cause the price of a good or service that was previously highly variable to become consistent enough for a stand-alone selling price to be estimated (as either a point estimate or a range).

Entities that use the residual approach to determine a stand-alone selling price should continually assess whether its use remains appropriate. In making this determination, entities should monitor and consider entity-specific and market conditions. A change from the residual approach to another method for determining a stand-alone selling price should be accounted for prospectively, and corresponding changes may need to be made to disclosures about the determination of the stand-alone selling price and allocation of the transaction price (e.g., ASC 606-10-50-17).

The examples below illustrate the application of the concepts described above.

Example 7-1

Entity S licenses its software to customers for terms ranging from one to five years. Along with its software licenses, S frequently sells other services such as PCS, professional services, or training, and it has observable stand-alone selling prices for such services. Taking into account market conditions, entity-specific factors, and information about customers or classes of customers, S stratifies its historical software sales data. It analyzes the pricing of the software and determines the following:

Fifteen percent of software transactions are priced between $150 and $1,200.
Thirty-five percent of software transactions are priced between $1,201 and $1,800 (plus or minus 20 percent concentration around a midpoint).
Thirty percent of software transactions are priced between $1,801 and $2,700 (plus or minus 20 percent concentration around a midpoint).
Twenty percent of software transactions are priced above $2,700.

There are no discernible concentrations within the above ranges.

On the basis of an analysis of the available observable data, including appropriate stratification of such data, S may conclude that it sells software licenses for a broad range of amounts and that therefore there is no discernible stand-alone selling price. Accordingly, the selling price of software licenses is highly variable. In addition, there are observable stand-alone selling prices for the other services in S’s contracts. If the resulting allocation under the residual approach meets the objective in ASC 606-10-32-28, the use of that method is acceptable.

Example 7-2

Assume the same facts as in Example 7-1 except that in this case, the software vendor, Entity K, determines the following:

Fifteen percent of software transactions are priced between $150 and $1,200.
Sixty-five percent of software transactions are priced between $1,201 and $1,800 (plus or minus 20 percent concentration around a midpoint).
Fifteen percent of software transactions are priced between $1,801 and $2,700 (plus or minus 20 percent concentration around a midpoint).
Five percent of software transactions are priced above $2,700.

Entity K determines that enough data points exist for it to conclude that there is a sufficient concentration of selling prices between $1,201 and $1,800.

While K sells software licenses for a broad range of amounts, there is a discernible range of stand-alone selling prices given the sufficient concentration of selling prices between $1,201 and $1,800. Accordingly, K may conclude that the selling price of its software license is not highly variable or uncertain.

Example 7-3

Entity B licenses its software to customers for terms ranging from one to five years. Along with its software licenses, B frequently sells other services such as PCS, professional services, or training, and it has observable stand-alone selling prices for such services. Taking into account market conditions, entity-specific factors, and information about the customer or class of customer, B stratifies its historical software sales data and analyzes the pricing of the software. Entity B determines that the vast majority of its software transactions are priced between $500 and $2,400 and that there are no discernible concentrations within that range. Further, the selling price range is consistent with B’s normal pricing policies and practices.

Entity B concludes that it is appropriate to use the residual approach to estimate the stand-alone selling price of its software license in contracts that contain other services. In a few of its contracts, application of the residual approach results in the allocation of between $0 and $50 to the software license performance obligation.

Entity B concludes that it should not use the residual approach to determine the stand-alone selling price of the software license for those contracts for which the residual approach results in the allocation of between $0 and $50 to the software license performance obligation.

Even though the selling price for the software license is highly variable, the allocation objective in ASC 606-10-32-28 is not met. This is because the amount allocated to the software license in a given transaction ($0 to $50) does not faithfully depict “the amount of consideration to which the entity expects to be entitled in exchange for transferring the promised goods or services to the customer.”

Since B typically prices its software between $500 and $2,400 and has no substantive history of selling software licenses for a price below $50 (i.e., such pricing is not indicative of its normal pricing policies and practices), those amounts do not represent substantive pricing. Accordingly, B must use another method or methods to determine the stand-alone selling price of its software license performance obligations.1 This conclusion is consistent with that in Case C in Example 34 in ASC 606-10-55-269. By contrast, if B’s application of the residual approach resulted in the allocation of between $500 and $2,400 to software license performance obligations, use of the residual may be reasonable since these amounts appear to be within B’s normal pricing policies and practices.

7.3.3.2.2 Allocating the Transaction Price When a Value Relationship Exists

ASC 606 does not provide guidance on estimating the stand-alone selling price of a good or service when the price of that good or service is dependent on the price of another good or service in the same contract. Entities in the software industry often sell PCS to customers in conjunction with a software license. Sometimes, PCS is priced as a percentage of the contractually stated selling price of the associated software license (e.g., 20 percent of the net license fee), including upon renewal. In these circumstances, as noted in Section 7.3.3.1, if an entity does not have observable pricing of PCS based on renewals of PCS priced at consistent dollar amounts, it may be appropriate for the entity to consider PCS renewals stated as a consistent percentage of the license fee to determine the observable stand-alone selling price for PCS. That is, even if an entity’s license pricing is highly variable and the dollar pricing of PCS in stand-alone sales (i.e., renewals) is therefore also highly variable, the observable stand-alone selling price of PCS may still be established if PCS renewals are priced at a consistent percentage of the license fee, the entity has consistent pricing practices, and the stand-alone selling price results in an allocation that is consistent with the overall allocation objective.

Although the revenue standard includes the residual approach as a suitable method for estimating the stand-alone selling price of a good or service in a contract, use of the residual approach is intended to be limited to situations in which the selling price of the good or service is highly variable or uncertain. Before applying the residual approach, an entity should consider whether (1) it has an observable stand-alone selling price for the good or service or (2) it can estimate the stand-alone selling price by using another method (e.g., adjusted market assessment or expected cost plus a margin approach). When the entity cannot determine the stand-alone selling price of the good or service by using another estimation method (e.g., because the stand-alone selling prices of the license and PCS, respectively, are highly variable), it may be appropriate to apply the residual approach. In some instances, a combination of approaches may be needed to determine stand-alone selling prices and the resulting transaction price allocation. On the basis of available data and established internal pricing strategies and practices related to licenses and PCS, an entity may determine that it has established a “value relationship” between the license and the PCS. If this value relationship is sufficiently consistent, the entity may use it to estimate the stand-alone selling prices of the license and PCS, respectively. For example, if the PCS is consistently priced and renewed at 20 percent of the net license fee, the entity may conclude that it is appropriate to consistently allocate 83 percent of the transaction price to the license (1 ÷ 1.2) and 17 percent to the PCS (0.2 ÷ 1.2).

In addition, if a license is not sold separately because it is always bundled with PCS, the entity might analyze its historical pricing for that bundle and conclude that such pricing is highly variable. If the bundle also includes another good or service (e.g., professional services) for which there is an observable stand-alone selling price, a residual approach may be appropriate for determining the combined stand-alone selling price for the license and PCS bundle if the resulting estimated stand-alone selling price is reasonable.

The example below illustrates these concepts.

Example 7-4

Entity X is a software vendor that licenses its software products to customers. The entity has determined that its licenses are functional IP in accordance with ASC 606-10-55-59.

Entity X enters into a contract with a customer to provide a perpetual software license bundled with one year of PCS and professional services in return for $100,000. While PCS and professional services are sold on a stand-alone basis, the license is never sold separately (i.e., it is always sold with PCS). Entity X concludes that the license, PCS, and professional services represent distinct performance obligations.

The contractually stated selling prices are as follows:

License — $70,000.
PCS — $14,000 (20 percent of $70,000).
Professional services — $16,000.

After analyzing sales of the bundled license and PCS (the “bundle”), X concludes that the pricing for the bundle is highly variable and that a residual approach is appropriate in accordance with ASC 606-10-32-34(c).

Entity X has an observable stand-alone selling price for professional services of $25,000. In addition, the PCS is consistently priced (and may be renewed) at 20 percent of the net license fee stated in the contract (for simplicity, a range is not used). Entity X determines that it has observable data indicating that there is a value relationship between the perpetual license and the PCS since the PCS is consistently priced at 20 percent of the contractually stated selling price of the license, including on a stand-alone basis upon renewal. Consequently, X concludes that the stand-alone selling price of the PCS is equal to 20 percent of the selling price of the license.

We believe that the two alternatives described below (“Alternative A” and “Alternative B”) are acceptable methods for allocating the transaction price to the performance obligations. To determine which alternative is more appropriate, an entity should consider the facts and circumstances of the arrangement. For example, we believe that when an entity has no (or insufficient) observable data available to determine the stand-alone selling price for the PCS, it generally would not be appropriate to use Alternative B.

Alternative A

Since the pricing of the bundle that comprises the license and the PCS is highly variable and there is an observable stand-alone selling price for the professional services, X may apply the residual approach to determine the stand-alone selling price of the bundle (step 1). If the resulting amount allocated to the bundle is reasonable and consistent with the allocation objective, X may then use the value relationship to determine how much of the transaction price that remains after allocation to the professional services should be allocated between the license and the PCS (step 2).

Step 1

Under step 1, X would determine the residual transaction price to be allocated to the bundle as follows:

Step 2

Next, under step 2, X would allocate the residual transaction price to the license and PCS as follows:

The table below summarizes the allocation of the total transaction price to the performance obligations.

Alternative B

Given that the pricing of the bundle comprising the license and the PCS is highly variable, X may determine that the pricing of the license is also highly variable since it has observable data indicating that there is a consistent value relationship between the license and the PCS. In addition, X may determine that it has an observable stand-alone selling price for the PCS since PCS is consistently priced at 20 percent of the contractually stated selling price of the license. Since X has observable stand-alone selling prices for the PCS and professional services, respectively, it may apply the residual approach to determine the stand-alone selling price of the license if the resulting amount allocated to the license is reasonable and consistent with the allocation objective.

Entity X would allocate the transaction price as follows:

The table below summarizes the allocation of the total transaction price to the performance obligations.

In selecting an appropriate alternative to determine a stand-alone selling price in accordance with ASC 606-10-32-33, an entity should consider “all information (including market conditions, entity-specific factors, and information about the customer or class of customer) that is reasonably available to the entity” and should “maximize the use of observable inputs.” Further, any allocation achieved through the use of the residual method should be (1) assessed for reasonableness and (2) consistent with the allocation objective in ASC 606-10-32-28.

While we believe that both of the alternatives discussed in the example above are acceptable methods for allocating the transaction price to the performance obligations, we acknowledge that practice may evolve over time. As practice evolves, the applicability of the alternatives described above is subject to change. Companies should continue to monitor changes in interpretations and consider consulting with their accounting advisers.

7.3.3.2.3 Material Right

Under ASC 606-10-55-41 through 55-45, a customer option to purchase additional goods or services gives rise to a material right if the option gives the entity’s customer a discount that is incremental to the range of discounts typically given for those goods or services to that class of customer (e.g., a customer in a particular geographic area or market). It would not be appropriate for the entity to conclude that no material right was conveyed to the customer simply because the selling prices of the goods or services that are subject to the option are highly variable or uncertain and the residual approach was therefore applied.

7.3.3.3 Different Stand-Alone Selling Price for the Same Good or Service in a Single Contract

The example below illustrates how the stand-alone selling price should be determined when the specified contract price for the same product changes over the term of the arrangement.

Example 7-5

Entity A enters into a contract to transfer 1,000 units of Product X to a customer each year for three years. The contract requires the customer to pay $10 for each unit delivered in year 1, $11 for each unit in year 2, and $12 for each unit in year 3.

ASC 606-10-32-32 states, in part, 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. A contractually stated price or a list price for a good or service may be (but shall not be presumed to be) the standalone selling price of that good or service.”

If the contractually stated price is representative of the value of each distinct good or service for the given period (i.e., it is considered to be the same as the stand-alone selling price), an entity could allocate consideration to the performance obligations on the basis of the contract pricing. However, A should consider the specific facts and circumstances of the arrangement as well as the reason for the different selling prices over the term of the contract. For example, if the contract prices have been set to reflect how the market price of Product X is expected to change over the three-year period, it may be appropriate to use the specified contract price as the stand-alone selling price for Product X in each year of the contract. Conversely, if there is no expectation that the market price of Product X will change over the three-year period, A may need to determine a single stand-alone selling price to be applied throughout the three-year contract term.

7.3.3.4 Different Selling Price for the Same Good or Service to Different Customers

The example below illustrates how a product’s stand-alone selling price should be determined when the product is sold to different customers under separate contracts that each specify a different selling price.

Example 7-6

Entity B enters into contracts to sell Product X to Customers C, D, and E. The contracts are negotiated separately, and each of the customers will pay a different unit price.

As previously noted, ASC 606-10-32-32 states, in part, 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. A contractually stated price or a list price for a good or service may be (but shall not be presumed to be) the standalone selling price of that good or service.”

The stand-alone selling price for a performance obligation (or distinct good or service) does not need to be a single amount. If the contractually stated price is representative of the value of each distinct good or service (i.e., it is considered to be the same as the stand-alone selling price), an entity could allocate consideration to the performance obligations on the basis of the contract pricing.

In the circumstances above, B should consider the specific facts and circumstances of the arrangement, as well as the reason for the different selling prices for different customers. There may be important differences between the transactions such that the sales are not in similar circumstances and to similar customers. For example, the transactions may be in different geographic markets or for different committed volumes, or the nature of the customer may be different (e.g., distributor, end user). If the sales are not in similar circumstances and to similar customers, the stand-alone selling price could be different for each customer, and it may be appropriate to use the specified contract price as the standalone selling price for each of the customers.

Conversely, if the sales are determined to be in similar circumstances and with similar customers, B may determine that there should be a single stand-alone selling price for all three customers on the basis of other evidence. It would then use that price to allocate the transaction price of the contracts with C, D, and E between Product X and any other performance obligations in those contracts, including when it applies ASC 606-10-32-36 through 32-38 to any discounts given against that stand-alone selling price.

7.3.3.5 Determining the Stand-Alone Selling Price for Multiperiod Commodity Contracts

Entities in commodities industry sectors, specifically oil and gas, power and utilities, mining and metals, and agriculture, often enter into multiyear contracts with their customers to provide commodities at a fixed price per unit. For example, an entity may enter into a contract to provide its customer 10,000 barrels of oil per month at a fixed price of $50 per barrel. For certain types of commodities, there may be a forward commodity pricing curve and actively traded contracts that establish pricing for all of or a portion of the contract duration. The forward commodity pricing curve may provide an indication of the price at which an entity could currently buy or sell a specified commodity for delivery in a specific month.

Sometimes, “strip” pricing may be available. In strip pricing, a single price is used to represent a single-price “average” of the expectations of the individual months in the strip period, which is typically referred to as a seasonal or annual strip. Terms of the multiperiod contracts are often derived, in part, in contemplation of the forward commodity pricing curve.

Certain arrangements may not meet the criteria in ASC 606-10-25-15 to be accounted for as a series of distinct goods that have the same pattern of transfer to the customer (and, therefore, as a single performance obligation). In these situations, when each commodity delivery is determined to be distinct, stakeholders have questioned whether entities are required to use the forward commodity pricing curve, the spot price, or some other value as the stand-alone selling price for allocating consideration to multiperiod commodity contracts.

We believe that entities should consider all of the relevant facts and circumstances, including market conditions, entity-specific factors, and information about the customer, in determining the stand-alone selling price of each promised good. We do not believe that entities should use forward-curve pricing by default in determining the stand-alone selling price; however, certain situations may indicate that the forward curve provides the best indicator of the stand-alone selling price. In other circumstances, the contract price may reflect the stand-alone selling price for the commodity deliveries under a particular contract. The determination of the contract price and the resulting allocation of the transaction price needs to be consistent with the overall allocation objective (i.e., to allocate the transaction price to each distinct good or service in an amount that depicts the amount of consideration to which the entity expects to be entitled in exchange for transferring the goods or services to the customer). Entities will need to use significant judgment in determining the stand-alone selling price in these types of arrangements.

7.3.3.6 Using a Range When Estimating a Stand-Alone Selling Price

Throughout ASC 606, the FASB uses the term “standalone selling price,” which is defined in ASC 606-10-20 and the ASC master glossary as the “price at which an entity would sell a promised good or service separately to a customer.” In the Codification’s definition, the FASB refers to the term in the singular rather than the plural. In ASC 606, this word choice is further emphasized in illustrative examples in which the stand-alone selling price is always expressed as a single-point observation or estimate of value (e.g., in Example 33, the directly observable stand-alone selling price of Product A is $50, and the estimated stand-alone selling price of Product B under an adjusted market approach is $25).

As a result, some have questioned whether the singular form of the defined term and the illustrations in the examples would preclude an entity from using anything other than a single-point observation or estimate as the stand-alone selling price (i.e., whether the guidance in ASC 606 precludes an entity from using a range of observations or estimates to establish a stand-alone selling price).

We believe that the stand-alone selling price for a performance obligation does not need to be a single amount. That is, the stand-alone selling price can be a range of amounts if the range is sufficiently narrow and concentrated, and the allocation of the transaction price that results from the identified stand-alone selling price is consistent with the general allocation objective in ASC 606-10-32-28 (i.e., “to allocate the transaction price to each performance obligation (or distinct good or service) in an amount that depicts the amount of consideration to which the entity expects to be entitled in exchange for transferring the promised goods or services to the customer”). See Section 7.3.3.6.1 for additional information about determining the appropriate range to estimate a stand-alone selling price.

7.3.3.6.1 Determining the Appropriate Range

When a range is used to estimate the stand-alone selling price, questions have arisen about how to determine whether the range is truly indicative of the stand-alone selling price.

Some entities (e.g., companies in the software industry) have developed a practice of estimating the stand-alone selling price as a range by demonstrating that a certain number of observable transactions are sufficiently clustered around a midpoint. For example, on the basis of an analysis of historical data (i.e., observable pricing), an entity may use a bell-shaped curve approach and determine that 75 percent of the sales of a particular good are priced within 15 percent of $5 (the midpoint) in either direction. Therefore, the stand-alone selling price range is $4.25 to $5.75. Both the distribution (i.e., width) of the range and the percentage of transactions clustered around the midpoint within that distribution (i.e., concentration) are important factors to consider in the determination of whether a range is truly indicative of the stand-alone selling price for a particular good or service.2

Some entities may instead establish the stand-alone selling price by using historical data on discounts off the list price. For example, if an entity consistently priced a particular good or service at 40 percent off the list price, the entity may establish the midpoint stand-alone selling price as 60 percent of the list price (100 percent less the 40 percent discount), provided that a sufficient number of transactions were discounted within a reasonable range of that midpoint. In such a case, a reasonable range might be 51 percent to 69 percent of the list price (calculated as 15 percent below and 15 percent above the midpoint of 60 percent of the list price). Alternatively, a reasonable range might be a discount of 34 percent to 46 percent off the list price (calculated as 15 percent below and 15 percent above the midpoint of 40 percent off the list price). Entities should consider whether the use of historical discounting data is sufficient and appropriate for establishing the stand-alone selling price.

ASC 606 does not prescribe or preclude any method for estimating the stand-alone selling price (exclusive of conditions that must be met for an entity to use the residual method). Likewise, ASC 606 does not establish any bright lines regarding which values or ranges are indicative of the stand-alone selling price, including the width and concentration of a given range. Instead, ASC 606 states that the stand-alone selling price of each distinct good or service should be a value “that depicts the amount of consideration to which the entity expects to be entitled in exchange for transferring the promised goods or services.”

Since the stand-alone selling price determined by using a range must meet the allocation objective in ASC 606-10-32-28, we believe that a particular range may not be appropriate if the concentration is too low, the width is too great, or both. For example, a stand-alone selling price range in which 60 percent of transactions fall within plus or minus 40 percent of a midpoint would most likely be too wide to meet the allocation objective. Likewise, a stand-alone selling price range in which 10 percent of transactions fall within plus or minus 15 percent of a midpoint would most likely not be sufficiently concentrated to meet the allocation objective. Entities must balance the narrowness of distribution with the adequacy of the concentration. That is, for an entity to establish the stand-alone selling price by using a range, both the concentration of transactions around the midpoint and the width thereof must be reasonable. For example, we believe that if an entity has maximized the use of observable inputs and has considered all reasonably available information, the entity would most likely meet the allocation objective in ASC 606-10-32-28 when using a stand-alone selling price range that (1) encompasses the majority of the relevant transactions (i.e., greater than 50 percent) and (2) has a width extending no greater than 20 percent from the midpoint in either direction.

We also believe that if there are not enough transactions within a reasonably narrow range, further disaggregation of the data (e.g., by contract value and geography in addition to product type) may be appropriate for determining reasonable stand-alone selling price ranges.3

If the resulting range does not meet the allocation objective after an entity has disaggregated the population of transactions, maximized the use of observable inputs, and considered all reasonably available information, the entity may need to apply other methods to establish the stand-alone selling price.

7.3.3.6.2 Allocation Considerations When the Stand-Alone Selling Price Is Established as a Range

An entity that establishes the stand-alone selling price as a range for a particular good or service will need to implement and consistently apply a policy related to when a contractually stated price does not represent the stand-alone selling price for any performance obligation (e.g., the contractually stated price is not within the established stand-alone selling price range) and reallocation is required. If a contractually stated price falls within the established stand-alone selling price range, it is considered “at stand-alone selling price,” and reallocation is therefore unnecessary unless required by other performance obligations in the contract (i.e., because the contractually stated price of another performance obligation is not at its stand-alone selling price). By contrast, if a contractually stated price is outside the stand-alone selling price range, reallocation is required. Accordingly, an entity will need to make a policy election regarding the point in the range that it will use for allocating the transaction price to each performance obligation on the basis of the stand-alone selling price. The following points are possible alternatives (not all-inclusive):

The midpoint in the range.
The outer point in the range, which would be:
- The high point in the range when the contractually stated price is greater than the high point in the range.
- The low point in the range when the contractually stated price is less than the low point in the range.
The low point in the range.
The high point in the range.

Once an entity elects a policy, the entity must ensure that the policy is consistently applied and that the resulting allocation meets the allocation objective in ASC 606-10-32-28.

7.3.3.7 Methods for Establishing the Stand-Alone Selling Price for Term Licenses and PCS

Questions have arisen regarding the determination of stand-alone selling prices when observable pricing from stand-alone sales (typically the most persuasive data point) does not exist for one or more performance obligations. In addition, contractually stated or list prices to be used as data points may not exist for one or more performance obligations. These circumstances frequently exist when term licenses are sold with PCS. Regardless of whether any of these circumstances apply, entities will generally have to estimate the stand-alone selling price of each performance obligation. We believe that in many such cases, there may be reasonably available observable data from which to determine the stand-alone selling prices.

Example 7-7

Market-Based Approach — Value Relationship

Entity A has developed a software solution similar to solutions offered by its peers. Although A’s solution has certain proprietary features that other competitors do not offer, A determines that the products are very comparable. Entity A licenses its software on a term basis. Each license includes coterminous PCS (i.e., PCS that begins and ends at the same time as the license term). Entity A has concluded that the license and PCS each constitute a distinct performance obligation.

Entity A always sells the license with the PCS. Given the coterminous nature of the PCS, there are no stand-alone renewals of PCS or stand-alone sales of term licenses. Entity A prices the license and PCS as a bundle and does not have any entity-specific information related to pricing for the term license and PCS separately. Consequently, there are no contractually stated or list prices for each performance obligation.

Entity A obtains data related to its competitors’ historical and current pricing of similar licenses and PCS. The data indicate that while pricing is variable, a value relationship exists between the pricing of licenses and the pricing of PCS. Specifically, on average, the data indicate that PCS for software products similar to those offered by A is consistently priced at 22–28 percent of the net license price.

We believe that A may use a market-based approach to estimate the stand-alone selling prices if the data represent reliable pricing information and the products are sufficiently similar. ASC 606-10-32-33 includes market conditions as information that could be used to estimate the stand-alone selling price of a promised good or service. In addition, paragraphs 9.4.31 and 9.4.34 of the AICPA Audit and Accounting Guide Revenue Recognition (the “AICPA Guide”) state the following, in part, regarding the estimation of the stand-alone selling price:

9.4.31 An entity’s estimate of the stand-alone selling price will require judgment and the consideration of a number of different factors. . . . A vendor may consider the following information when estimating the stand-alone selling price of the distinct goods or services included in a contract:

a. Historical selling prices for any stand-alone sales of the good or service (for example, stand-alone maintenance renewals), even if limited stand-alone sales exist. An entity will have to consider its facts and circumstances to determine how relevant historical pricing is to the determination of current stand-alone selling price. For example, if an entity recently changed its pricing strategy, historical pricing data is likely less relevant for the current determination of stand-alone selling price.

b. Historical selling prices for non-stand-alone sales/bundled sales.

c. Competitor pricing for a similar product, especially in a competitive market or in situations in which the entities directly compete for customers.

d. Vendor’s pricing for similar products, adjusting for differences in functionality and features.

e. Industry pricing practices for similar products.

f. Profit and pricing objectives of the entity, including pricing practices used to price bundled products.

g. Effect of proposed transaction on pricing and the class of the customer (for example, the size of the deal, the characteristics of the targeted customer, the geography of the customer, or the attractiveness of the market in which the customer resides).

h. Published price lists.

i. The costs incurred to manufacture or provide the good or service, plus a reasonable profit margin.

j. Valuation techniques; for example, the value of intellectual property could be estimated based on what a reasonable royalty rate would be for the use of intellectual property.

9.4.34 Depending on the inherent uniqueness of a license to proprietary software and the related vendor maintenance, third-party or industry pricing may or may not be useful for determining stand-alone selling price of distinct goods or services included in these arrangements. When evaluating whether third-party or industry pricing is a relevant and reliable basis for establishing the stand-alone selling price, the data points should be based on information of comparable items sold on a stand-alone basis to similar types of customers. Products or services are generally similar if they are largely interchangeable and can be used in similar situations by similar customers. For these reasons, third-party or industry pricing for software licenses may not be a relevant data point. However, third-party or industry pricing may be a relevant data point for estimating stand-alone selling price for maintenance, hosting, or professional services if other vendors sell similar services on a stand-alone basis and their pricing is known by the vendor. For example, third-party pricing may be a relevant data point if other vendors provide implementation services or host the vendor’s software products. [Emphasis added]

In accordance with the guidance above, if A’s software solution is similar to solutions offered by its peers and the market data are reliable, A may use a market-based approach to estimate the stand-alone selling prices by using the pricing data related to its peers. Under such an approach, A may conclude that the stand-alone selling price of the PCS is 25 percent of the net selling price of the license (i.e., the midpoint of the stand-alone selling price range that A determined through its analysis of available observable market data), which may also be expressed as 20 percent of the bundle price (0.25 ÷ 1.25). Consequently, A may also conclude that the stand-alone selling price of the license is equal to 80 percent of the bundle price.

Example 7-8

Entity-Specific Approach — Value Relationship

Entity B licenses its proprietary software on a term basis for five years. There are no other similar products4 on the market, and because any incremental direct costs involved in the production and distribution of copies of B’s software product are minimal, B does not use cost as a basis for establishing pricing. Customers are required to purchase one year of PCS in conjunction with any license purchase. Consequently, licenses are never sold on a stand-alone basis. On the basis of B’s historical experience, PCS is consistently priced at approximately 20 percent of the contractually stated net license fee for both the initial purchase and any subsequent renewals. Therefore, observable stand-alone sales of PCS exist upon renewal. Further, B has concluded that the license and PCS each constitute a distinct performance obligation.

It may be reasonable for B to use the approach described below to estimate the stand-alone selling prices.

Since there are no similar software products on the market, B does not use a market-based approach to estimate the stand-alone selling price of the license. In addition, because the incremental direct costs involved in the production and distribution of copies of B’s software product are minimal and such costs are not used as a basis for establishing pricing, B does not use a cost-based approach to estimate the stand-alone selling price of the license. However, B determines that observable data and pricing practices demonstrate the existence of a value relationship between the license and the PCS (PCS is consistently priced at 20 percent of the net license fee).

Paragraphs 9.4.34 and 9.4.44 of the AICPA Guide state the following, in part, regarding the concept of a value relationship:

9.4.34 [O]ver time, the software industry has developed a common practice of pricing maintenance services as a percentage of the license fee for related software products, indicating there may be a consistent value relationship between those two items. . . .

9.4.44 [The] lack of history of selling goods or services on a stand-alone basis combined with minimal direct costs and a lack of third-party or industry-comparable pricing may result in some software vendors focusing on entity-specific and market factors when estimating stand-alone selling price of both the license or the maintenance such as internal pricing strategies and practices. That is, based on its established pricing practices, an entity may conclude that it has established a value relationship between a software product and the maintenance that is helpful in determining stand-alone selling price.

In a manner consistent with the guidance above, B determines that the value relationship between the term license and the PCS for establishing their respective stand-alone selling prices in a given contract is a ratio of 83 percent (1 ÷ 1.2) to 17 percent (0.2 ÷ 1.2). Therefore, if the transaction price for a contract is $120, B would allocate $100 to the license and $20 to the PCS.5

Example 7-9

Entity-Specific Approach — Observable Data From Perpetual Licenses

Entity C has developed a unique proprietary software solution. The entity licenses this software on a perpetual basis and has determined that the economic useful life of the software is five years. All customers are required to purchase at least one year of PCS when they purchase a license. Consequently, licenses are never sold on a stand-alone basis. On the basis of C’s historical experience, PCS is consistently priced at approximately 20 percent of the contractually stated net license fee for both the initial purchase and any subsequent stand-alone renewals. In addition, C has determined from historical experience that customers typically purchase a total of five years of PCS over the life of a perpetual license.

Like Entity B in Example 7-8, C does not use a market- or cost-based approach to estimate the stand-alone selling price of a license. Therefore, C estimates the stand-alone selling prices of a perpetual license and PCS, respectively, by using the value relationship observed between the license and PCS (i.e., 83%/17%).

Entity C charges an up-front fee of $100 for a perpetual license and prices PCS at 20 percent of the license fee both initially and upon renewal. The resulting value relationship between a perpetual license and PCS, which varies depending on the total years of PCS purchased, is shown in the table below.

Entity C also licenses the same software product discussed above on a term basis for five years. Each sale of a term license is bundled with coterminous PCS (i.e., PCS that begins and ends at the same time as the license term). Entity C has concluded that the term license and PCS each constitute a distinct performance obligation. The term license is always sold with PCS, and given the coterminous nature of the PCS, there are no stand-alone renewals of PCS on term licenses. That is, stand-alone sales of PCS and term licenses do not occur. Entity C prices term licenses and PCS as a bundle; consequently, contractually stated prices for a term license and PCS individually are unavailable. However, C determines that its internal pricing process for a term license (1) is similar to that for a perpetual license and (2) takes into consideration the length of a term license relative to renewals of PCS on a perpetual license.

It may be reasonable for C to use the approach described below to estimate the stand-alone selling prices.

Entity C considers the observable entity-specific information related to its perpetual licenses to estimate the stand-alone selling price of a five-year term license and that of the associated PCS.

Paragraph 9.4.32 of the AICPA Guide states the following:

The quantity and type of reasonably available data points used in determining stand-alone selling price will not only vary among software vendors but may differ for products or services offered by the same vendor. Furthermore, with respect to software licenses, reasonably available data points may vary for the same software product that has differing attributes/licensing rights (that is, perpetual versus term license, exclusive versus nonexclusive). For example, a vendor may have stand-alone observable sales of the maintenance services in its perpetual software license (that is, maintenance renewals). These observable sales may be a useful data point for similar maintenance services bundled with other types of software licenses (for example, term licenses). [Emphasis added]

In a manner consistent with the guidance above, an entity may consider observable data related to the value relationship between a perpetual license and the associated PCS to be a relevant and useful data point in determining the stand-alone selling prices of term licenses for the same software and the associated PCS, especially when other observable data are limited or nonexistent. While the entity should not presume such data to be determinative when estimating the stand-alone selling prices, we acknowledge that in certain cases in which the observable inputs for the determination of stand-alone selling prices for term licenses and PCS are limited to data on the same licenses and PCS sold on a perpetual basis, such data may represent the best available information for making the determination.

Legacy guidance in AICPA Technical Q&As Section 5100.68 indicates that the value of PCS for a term license is different from that of PCS for the same license sold on a perpetual basis because upgrades and enhancements associated with the latter are retained indefinitely. AICPA Technical Q&As Section 5100.68 states, in part:

PCS services for a perpetual license and PCS services for a multi-year time-based license are two different elements. Though the same unspecified product upgrades or enhancements may be provided under each PCS arrangement, the time period during which the software vendor’s customer has the right to use such upgrades or enhancements differs based on the terms of the underlying licenses. Because PCS services are bundled for the entire term of the multi-year time-based license, those PCS services are not sold separately. [Emphasis added]

While this guidance has been superseded by ASC 606, we believe that the concept that differences in value may exist between PCS for a term license and PCS for a perpetual license remains valid. However, we also note that AICPA Technical Q&As Section 5100.68 goes on to state the following:

[I]n the rare situations in which both of the following circumstances exist, the PCS renewal terms in a perpetual license provide [vendor-specific objective evidence] of the fair value of the PCS services element included (bundled) in the multi-year time-based software arrangement: (1) the term of the multi-year time-based software arrangement is substantially the same as the estimated economic life of the software product and related enhancements that occur during that term; and (2) the fees charged for the perpetual (including fees from the assumed renewal of PCS for the estimated economic life of the software) and multi-year time-based licenses are substantially the same. [Emphasis added]

Similarly, pricing data from transactions involving a perpetual license may, in certain situations, be relevant to the determination of the stand-alone selling prices for a term license and associated PCS. This concept is similar to that of the above-referenced guidance in paragraph 9.4.32 of the AICPA Guide, but determining the stand-alone selling price for a term license under ASC 606 on the basis of pricing for a perpetual license is more flexible than under legacy U.S. GAAP. Nonetheless, pricing data for the perpetual license should not be considered in isolation from the facts and circumstances associated with the term license. Paragraph 9.4.51 of the AICPA Guide states the following:

As discussed in paragraph 9.4.44, a software vendor may have established a value relationship between the perpetual software license and the maintenance services for that license that influences the vendor’s determination of stand-alone selling price for each of those items. Given that the underlying products (software license) and services (technical support and unspecified upgrades and enhancements) are similar for both a perpetual and a term license arrangement, FinREC believes that the renewal pricing for the maintenance associated with one type of license (for example, a percentage of the license fee for a perpetual license) would be a good starting point for establishing stand-alone selling price for the maintenance associated with the license without renewal pricing. Entities would have to determine whether the stand-alone selling price of the maintenance for one type of license would be different from the other type of license. Management would need to carefully analyze its particular facts and circumstances and the related market dynamics, but should consider any stand-alone renewal transaction data, adjusting as necessary for the type of license, in formulating its stand-alone selling price. For example, some vendors may determine that the renewal rates would not differ based on market dynamics. Conversely, other vendors may determine that the ability to use the updates provided in maintenance associated with perpetual or longer-term licenses might cause that maintenance to have higher pricing. [Emphasis added]

In a manner consistent with the guidance above and C’s internal pricing process, C determines that the value relationship observed between sales of perpetual licenses and the associated PCS is the best available observable information for estimating the stand-alone selling price of the term license and that of the associated PCS. Therefore, after considering all of the facts and circumstances, C estimates the stand-alone selling prices of the term license and PCS, respectively, by using the value relationship observed in the sale of a perpetual license with five total years of PCS, or 50%/50%.

We believe that this example may be expanded to include various scenarios in which the economic useful life of the perpetual license is not equivalent to the term of the term license. In such cases, various factors could be considered, including, but not limited to, the following:

The expected term (i.e., the stated duration of the term license and PCS as well as subsequent renewals of both) of the term license as compared with the economic useful life of the perpetual license.
The initial term of the term license as compared with the economic useful life of the perpetual license.
Renewals of the term license and associated PCS as compared with renewals of PCS for the perpetual license.
The internal pricing process and practices (e.g., if the internal pricing process and practices for the term license are consistent with those for the perpetual license inclusive of PCS renewals, the value relationship table for the perpetual license may be more relevant).
The pace of technological advancement that could affect whether the customer is more likely to renew the term license (rather than upgrade to a new version or buy a license to a different software product).

Example 7-10

High Renewal Rates and Expected Term

It may be reasonable for C to use the approach described below to estimate the stand-alone selling prices of the two-year term license and PCS.

In addition to the facts outlined above, assume the following:

The transaction price for the initial two-year term license with coterminous PCS is $100 and is paid up front.
The transaction price for the three annual renewals of the coterminous term license and PCS is $50 per year.

The license revenue will be recognized up front ($50 in year 1 and $25 at the start of years 3, 4, and 5 as renewals occur) when the customer obtains the right to use and benefit from the software in accordance with ASC 606-10-55-58C. PCS revenue will be recognized over time ($50 over the first two-year period for the initial two-year PCS and then $25 over each subsequent one-year period as renewals occur), typically on a straight-line (i.e., ratable) basis because of the stand-ready nature of most PCS offerings.

The table below summarizes the allocation of the transaction price and associated revenue recognition.

Example 7-11

Low Renewal Rates and Expected Term

Assume the same facts as in Example 7-9, except that Entity C sells (1) a term license with an initial one-year term, (2) coterminous PCS, and (3) annual renewals of both the term license and PCS on a bundled basis. On the basis of historical experience, only 10 percent of C’s customers are expected to renew the license and PCS for one additional year. Entity C believes that it (1) would not price its one-year term license and PCS differently from its perpetual license with one year of PCS and (2) does not have any other observable information that would indicate that the pricing of its one-year term license and PCS would be different from the pricing of its perpetual license with one year of PCS.

It may be reasonable for C to use the approach described below to estimate the stand-alone selling prices.

In a manner similar to that discussed in Example 7-9, C determines that the value relationship observed between sales of perpetual licenses and the associated PCS is the best available observable information for estimating the stand-alone selling price of the term license and that of the associated PCS. However, C considers that the expected term of the term license and PCS (i.e., the term that is inclusive of anticipated renewals) is substantially different from the economic useful life of the perpetual license because the term license and associated PCS are infrequently renewed beyond the initial term. In addition, the initial term of the term license is only one year. However, C does not believe that it would price the two types of licenses and PCS differently. That is, even though the rights associated with the software and PCS for a perpetual license are different from those associated with the software and PCS for a term license, C believes that it would price the licenses and the one-year PCS in the same manner. Therefore, after considering all of the facts and circumstances, C estimates the stand-alone selling prices of the term license and PCS, respectively, by using the value relationship observed in the sale of a perpetual license with one year of PCS, or approximately 83%/17%. Since C does not have any other observable information that conflicts with the 83%/17% split, and management asserts that it would not price term licenses differently, the only — and, therefore, best — observable information is the value relationship observed in sales of perpetual licenses with one year of PCS.

Example 7-12

Moderate Renewal Rates and Expected Term

Assume the same facts as in Example 7-9, except that Entity C sells (1) a term license with an initial two-year term, (2) coterminous PCS, and (3) annual renewals of both the term license and PCS on a bundled basis. On the basis of historical experience, 70 percent of C’s customers are expected to renew the license and PCS on an annual basis. While there is no consistent pattern of renewals, most customers that renew do so for one or two years. In addition, C has an internal pricing policy that indicates that renewals of the term license should be targeted at approximately 67 percent (per additional year) of the original annualized transaction price, while renewals of PCS should be targeted at approximately 33 percent (per additional year) of the original annualized transaction price.

It may be reasonable for C to use the approach described below to estimate the stand-alone selling prices.

Entity C determines that its internal pricing policy and the value relationship observed between sales of perpetual licenses and the associated PCS constitute the best available information for estimating the stand-alone selling price of the term license and that of the associated PCS. The entity considers that the expected term of the term license and PCS (i.e., the term that is inclusive of anticipated renewals) is most likely greater than the initial two-year term given the renewal rate of 70 percent but is most likely shorter than the economic useful life of a perpetual license. Consequently, by using the observable data related to the value relationship between a perpetual license and various durations of PCS, C determines that a value relationship between the term license and the PCS should be between 71%/29% (perpetual license with two years of PCS) and 50%/50% (perpetual license with five years of PCS). Entity C also considers its internal pricing policy and notes that the policy indicates a value relationship closer to 67%/33%. Accordingly, after considering all of the facts and circumstances, C estimates the stand-alone selling prices of the term license and PCS, respectively, by using the value relationship observed in the sale of a perpetual license with three years of PCS, or approximately 62%/38%.

Footnotes

One method may be to use the range of observable pricing in other transactions for which the stand-alone selling prices were determined to be reasonable and in line with B’s normal pricing policies and practices.

Some entities may instead apply a method similar to a bell-shaped curve approach to determine a single-point estimate of the stand-alone selling price of a performance obligation (e.g., by using the midpoint within the distribution as the stand-alone selling price). This section addresses only circumstances in which the stand-alone selling price is determined as a range.

The level of disaggregation may depend, in part, on an entity’s pricing policies and practices.

Even when similar products do exist, reliable pricing information may not be available for determining stand-alone selling prices under a market-based approach.

If B had determined that pricing for its software product is highly variable under ASC 606-10-32-34(c)(1) and that an observable stand-alone selling price exists for PCS, it would have been reasonable for B to conclude that a residual approach is appropriate. This approach may yield an answer similar to the one resulting from the value relationship approach described above.

Confidential and Proprietary — for Use Solely by Authorized Personnel

This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.