Chapter 7 — Step 4: Allocate the Transaction Price to the Performance Obligations
Chapter 7 — Step 4: Allocate the Transaction Price to the Performance Obligations
7.1 Background
In step 4 of the revenue standard, an entity allocates the
transaction price to each of the identified performance obligations. For a contract
containing more than one performance obligation, the allocation is generally
performed on the basis of the relative stand-alone selling price of each performance
obligation. However, as discussed below, there are exceptions that allow an entity
to allocate a disproportionate amount of the transaction price to a specific
performance obligation or distinct good or service. For example, an entity may
allocate a discount to a single performance obligation rather than proportionately
to all performance obligations if certain factors indicate that the discount is
related to a specific performance obligation.
ASC 606-10
32-28 The objective when allocating
the transaction price is for an entity 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.
7.2 Stand-Alone Selling Price
ASC 606-10
32-29 To meet the allocation
objective, an entity shall allocate the transaction price to
each performance obligation identified in the contract on a
relative standalone selling price basis in accordance with
paragraphs 606-10-32-31 through 32-35, except as specified
in paragraphs 606-10-32-36 through 32-38 (for allocating
discounts) and paragraphs 606-10-32-39 through 32-41 (for
allocating consideration that includes variable
amounts).
32-30 Paragraphs 606-10-32-31
through 32-41 do not apply if a contract has only
one performance obligation. However, paragraphs
606-10-32-39 through 32-41 may apply if an entity
promises to transfer a series of distinct goods or
services identified as a single performance
obligation in accordance with paragraph 606-10-
25-14(b) and the promised consideration includes
variable amounts.
The principle of allocating the transaction price to each performance obligation
is that consideration should be allocated on the basis of the relative stand-alone
selling price of each distinct good or service in the contract. The result of
allocating consideration on this basis should be consistent with the overall core
principle of the revenue standard (i.e., to recognize revenue in an amount that
depicts the consideration to which the entity expects to be entitled in exchange for
the promised goods or services).
ASC 606-10-32-29 requires an entity to allocate the transaction price to each performance obligation on
a relative stand-alone selling price basis. In determining the allocation, an entity is required to maximize
the use of observable inputs. When the stand-alone selling price of a good or service is not directly
observable, an entity is required to estimate the stand-alone selling price. The example below, which is
reproduced from ASC 606, illustrates how to apply the standard’s allocation method.
ASC 606-10
Example 33 — Allocation Methodology
55-256 An entity enters into a contract with a customer to sell Products A, B, and C in exchange for $100. The
entity will satisfy the performance obligations for each of the products at different points in time. The entity
regularly sells Product A separately, and, therefore the standalone selling price is directly observable. The
standalone selling prices of Products B and C are not directly observable.
55-257 Because the standalone selling prices for Products B and C are not directly observable, the entity must
estimate them. To estimate the standalone selling prices, the entity uses the adjusted market assessment
approach for Product B and the expected cost plus a margin approach for Product C. In making those
estimates, the entity maximizes the use of observable inputs (in accordance with paragraph 606-10-32-33). The
entity estimates the standalone selling prices as follows:
55-258 The customer receives a discount for purchasing the bundle of goods because the sum of the
standalone selling prices ($150) exceeds the promised consideration ($100). The entity considers whether it
has observable evidence about the performance obligation to which the entire discount belongs (in accordance
with paragraph 606-10-32-37) and concludes that it does not. Consequently, in accordance with paragraphs
606-10-32-31 and 606-10-32-36, the discount is allocated proportionately across Products A, B, and C. The
discount, and therefore the transaction price, is allocated as follows:
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:
-
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).
-
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
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, 95 percent of
C’s customers are expected to renew the license and
PCS on an annual basis for at least three additional
years.
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 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. Entity C considers that the expected term of
the term license and PCS (i.e., the term that is
inclusive of anticipated renewals) is greater
than the initial two-year term and approximates the
economic useful life of the perpetual license. That
is, C concludes that a two-year term license with
coterminous PCS and annual renewals is not
substantially different from a five-year term
license with coterminous PCS since the term license
and PCS are renewed annually 95 percent of the time
for an additional three years. Therefore, after
considering all 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%.
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
1
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.
2
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.
3
The level of disaggregation may depend, in part,
on an entity’s pricing policies and practices.
4
Even when similar products do exist, reliable
pricing information may not be available for
determining stand-alone selling prices under a
market-based approach.
5
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.
7.4 Allocation of a Discount
It is not uncommon for contracts containing multiple goods and services to
include a discounted bundled price rather than the sum of the individual goods’ or
services’ respective stand-alone selling prices (see the Codification example in
Section 7.2). In accordance
with the general allocation principle discussed in Section 7.2, the discounted transaction price
is allocated proportionately to each distinct good and service on the basis of its
relative stand-alone selling price. However, there may be instances in which the
result of this allocation approach does not faithfully depict the amount of
consideration to which the entity expects to be entitled in exchange for the
underlying goods or services. That is, the allocation approach may result in revenue
recognition that is inconsistent with the core principle in the revenue standard.
This may occur, for example, if certain goods or services are routinely sold at a
very low margin while others are routinely sold at a very high margin. An entity may
routinely discount the high-margin goods or services but not discount the low-margin
goods or services. Allocating a discount proportionately to these goods or services
may result in an allocated amount that does not accurately depict the amount of
consideration to which the entity expects to be entitled in exchange for the goods
or services. Consequently, ASC 606-10-32-37 provides an exception for allocating a
discount to one or more, but not all, distinct goods or services in a contract if
certain criteria are met.
ASC 606-10
32-36 A customer receives a discount for purchasing a bundle of goods or services if the sum of the
standalone selling prices of those promised goods or services in the contract exceeds the promised
consideration in a contract. Except when an entity has observable evidence in accordance with paragraph
606-10-32-37 that the entire discount relates to only one or more, but not all, performance obligations in a
contract, the entity shall allocate a discount proportionately to all performance obligations in the contract. The
proportionate allocation of the discount in those circumstances is a consequence of the entity allocating the
transaction price to each performance obligation on the basis of the relative standalone selling prices of the
underlying distinct goods or services.
32-37 An entity shall allocate a discount entirely to one or more, but not all, performance obligations in the
contract if all of the following criteria are met:
- The entity regularly sells each distinct good or service (or each bundle of distinct goods or services) in the contract on a standalone basis.
- The entity also regularly sells on a standalone basis a bundle (or bundles) of some of those distinct goods or services at a discount to the standalone selling prices of the goods or services in each bundle.
- The discount attributable to each bundle of goods or services described in (b) is substantially the same as the discount in the contract, and an analysis of the goods or services in each bundle provides observable evidence of the performance obligation (or performance obligations) to which the entire discount in the contract belongs.
32-38 If a discount is allocated entirely to one or more performance obligations in the contract in accordance
with paragraph 606-10-32-37, an entity shall allocate the discount before using the residual approach to
estimate the standalone selling price of a good or service in accordance with paragraph 606-10-32-34(c).
Paragraph BC283 of ASU 2014-09 summarizes the views of the FASB and IASB on the application of ASC
606-10-32-37:
The Boards . . . noted that paragraph 606-10-32-37 would typically apply to contracts for which there are at least
three performance obligations. This is because an entity could demonstrate that a discount relates to two or
more performance obligations when it has observable information supporting the standalone selling price of a
group of those promised goods or services when they are sold together. The Boards noted it may be possible
for an entity to have sufficient evidence to be able to allocate a discount to only one performance obligation in
accordance with the criteria in paragraph 606-10-32-37, but the Boards expected that this could occur in only rare
cases.
The example below, which is reproduced from ASC 606, illustrates how an entity would
allocate a discount when there are multiple performance obligations.
ASC 606-10
Example 34 — Allocating a Discount
55-259 An entity regularly sells
Products A, B, and C individually, thereby establishing the
following standalone selling prices:
55-260 In addition, the entity
regularly sells Products B and C together for $60.
Case A — Allocating a Discount to One or
More Performance Obligations
55-261 The entity enters into a
contract with a customer to sell Products A, B, and C in
exchange for $100. The entity will satisfy the performance
obligations for each of the products at different points in
time.
55-262 The contract includes a
discount of $40 on the overall transaction, which would be
allocated proportionately to all 3 performance obligations
when allocating the transaction price using the relative
standalone selling price method (in accordance with
paragraph 606-10-32-36). However, because the entity
regularly sells Products B and C together for $60 and
Product A for $40, it has evidence that the entire discount
should be allocated to the promises to transfer Products B
and C in accordance with paragraph 606-10-32-37.
55-263 If the entity transfers
control of Products B and C at the same point in time, then
the entity could, as a practical matter, account for the
transfer of those products as a single performance
obligation. That is, the entity could allocate $60 of the
transaction price to the single performance obligation and
recognize revenue of $60 when Products B and C
simultaneously transfer to the customer.
55-264 If the contract requires the
entity to transfer control of Products B and C at different
points in time, then the allocated amount of $60 is
individually allocated to the promises to transfer Product B
(standalone selling price of $55) and Product C (standalone
selling price of $45) as follows:
Case B — Residual Approach Is
Appropriate
55-265 The entity enters into a
contract with a customer to sell Products A, B, and C as
described in Case A. The contract also includes a promise to
transfer Product D. Total consideration in the contract is
$130. The standalone selling price for Product D is highly
variable (see paragraph 606-10-32-34(c)(1)) because the
entity sells Product D to different customers for a broad
range of amounts ($15 – $45). Consequently, the entity
decides to estimate the standalone selling price of Product
D using the residual approach.
55-266 Before estimating the
standalone selling price of Product D using the residual
approach, the entity determines whether any discount should
be allocated to the other performance obligations in the
contract in accordance with paragraphs 606-10-32-37 through
32-38.
55-267 As in Case A, because the
entity regularly sells Products B and C together for $60 and
Product A for $40, it has observable evidence that $100
should be allocated to those 3 products and a $40 discount
should be allocated to the promises to transfer Products B
and C in accordance with paragraph 606-10-32-37. Using the
residual approach, the entity estimates the standalone
selling price of Product D to be $30 as follows:
55-268 The entity observes that the
resulting $30 allocated to Product D is within the range of
its observable selling prices ($15 – $45). Therefore, the
resulting allocation (see above table) is consistent with
the allocation objective in paragraph 606-10-32-28 and the
guidance in paragraph 606-10-32-33.
Case C — Residual Approach Is
Inappropriate
55-269 The same facts as in Case B
apply to Case C except the transaction price is $105 instead
of $130. Consequently, the application of the residual
approach would result in a standalone selling price of $5
for Product D ($105 transaction price less $100 allocated to
Products A, B, and C). The entity concludes that $5 would
not faithfully depict the amount of consideration to which
the entity expects to be entitled in exchange for satisfying
its performance obligation to transfer Product D because $5
does not approximate the standalone selling price of Product
D, which ranges from $15 – $45. Consequently, the entity
reviews its observable data, including sales and margin
reports, to estimate the standalone selling price of Product
D using another suitable method. The entity allocates the
transaction price of $105 to Products A, B, C, and D using
the relative standalone selling prices of those products in
accordance with paragraphs 606-10-32-28 through 32-35.
The two examples below further illustrate how an entity may allocate
a discount in a contract.
Example 7-13
Entity W regularly sells Item A, Item B, and
Item C on a stand-alone basis. The stand-alone selling price
of each item is shown in the following table:
On January 1, 20X1, W enters into a contract
with a customer to provide the customer with one of each
item for consideration of $135 (a $15 discount) in
accordance with the following schedule:
Assume that W also sells bundles regularly
at combined prices as follows:
On the basis of the selling prices of the
bundled goods, the entity does not
have sufficient evidence to demonstrate that the discount in
the contract is related to any specific performance
obligation (i.e., the evidence does not support a
determination that the discount is anything more than a
volume-based discount attributable to a customer’s purchase
of a bundle of items).
Accordingly, the discount of $15 should be
allocated pro rata to each of the performance obligations on
the basis of their individual stand-alone selling prices as
follows:
The entity would therefore recognize revenue
as follows:
-
When Item A is transferred, recognize revenue of $27 ($30 – $3).
-
When Item B is transferred, recognize revenue of $63 ($70 – $7).
-
When Item C is transferred, recognize revenue of $45 ($50 – $5).
Thus, the total revenue recognized on the
contract is $135 ($27 + $63 + $45).
Example 7-14
Assume the same facts as in the example
above, except that the entity regularly sells bundles at
combined prices as follows:
In this scenario, the evidence based on the
selling prices of the bundled goods supports a determination
that (1) there is a discount of $15 when the entity sells a
bundle of two items that includes Item A and (2) there is a
discount of $0 for all other bundles that contain items
other than Item A. Consequently, it is reasonable to
conclude that the discount of $15 should be allocated
entirely to Item A in accordance with ASC 606-10-32-37.
The entity would recognize revenue as
follows:
-
When Item A is transferred, recognize revenue of $15 ($30 [stand-alone selling price of Item A] – $15 [full discount]).
-
When Item B is transferred, recognize revenue of $70.
-
When Item C is transferred, recognize revenue of $50.
Thus, the total revenue recognized on the
contract is $135 ($15 + $70 + $50).
7.4.1 Application of the Discount Allocation Guidance to Goods or Services Not Sold Separately
Generally, for the criterion in ASC 606-10-32-37(a) to be met,
the entity will regularly sell and therefore have observable prices for all of
the performance obligations in the contract to allocate a discount to one or
more (rather than all) of the performance obligations. However, there may be
instances in which an entity does not regularly sell each distinct good or
service, but regularly sells some of the distinct goods and services as a bundle
and regularly sells other distinct goods and services separately. In these
cases, an entity may be able to conclude that the discount is allocable to the
bundle of distinct goods and services.
This determination requires judgment. In all cases, an entity
should maximize the use of observable evidence when determining stand-alone
selling prices and allocating discounts. An entity should exercise caution when
considering whether to allocate a discount in an arrangement to a distinct good
or service that is not sold separately since the stand-alone selling price needs
to be estimated.
The example below illustrates how an entity may allocate a
discount to a bundle of distinct goods and services.
Example 7-15
Company X enters into a contract to sell
License A, Service B, and Service C. In addition, X
regularly sells, and therefore has observable evidence
of sales of, a bundle consisting only of License A and
Service B (“Bundle A + B”) for $50 and also regularly
sells Service C for $20.
The tables below show the stand-alone
selling price of each distinct good and service and each
bundle of distinct goods and services that X sells.
Scenario 1: Contract
Price = $70
As shown below, the value of the
discount (in dollars) in this scenario is the same for
(1) X’s observable and regular sales of Bundle A + B and
(2) the contract that requires X to transfer License A,
Service B, and Service C.
Since the observable sales price of
Bundle A + B plus the observable sales price of Service
C is equal to the contract price, there is no
incremental discount for purchasing Service C in
addition to Bundle A + B. Accordingly, X should
attribute to Bundle A + B the discount of $15 off the
total of License A’s and Service B’s respective
stand-alone selling prices to arrive at the observable
selling price of License A and Service B when sold
together.
If necessary (e.g., if the time at which
control of License A is transferred is different from
when control of Service B is transferred), $50 of
consideration (inclusive of the discount of $15) should
be allocated between License A and Service B on a
relative stand-alone selling price basis (step 2
allocation in the table below). In this fact pattern,
the absence of observable stand-alone sales of License A
does not prohibit the application of the guidance on
allocating discounts in ASC 606-10-32-27 to Bundle A +
B. Note, however, that the guidance could not be applied
if X lacked observable stand-alone selling prices for
either Service C or Bundle A + B.
The resulting allocations are as
follows:
Scenario 2: Contract
Price = $60
As shown below, when the contract price
for purchasing License A, Service B, and Service C is
$60, the contract includes a $25 discount in comparison
with the sum of the stand-alone selling prices of
License A, Service B, and Service C. Because the $25
discount in this contract is not the same as the $15
discount that a customer receives when purchasing
License A and Service B together, the $25 discount must
be allocated to each distinct good or service in the
contract.
Because the discount for purchasing
Bundle A + B ($15) is not substantially the same as the
discount provided in the contract ($25), the criterion
in ASC 606-10-32-37(c) is not met. Therefore, X may not
allocate the discount in the contract entirely to Bundle
A + B. Rather, the $25 discount should be allocated to
each distinct good or service on a relative stand-alone
selling price basis. The resulting allocations are as
follows:
Connecting the Dots
Entities often sell their goods and services in bundles
priced at a discount instead of selling each good or service separately.
Stakeholders have questioned whether the guidance in ASC 606-10-32-37 on
allocating discounts to one or more, but not all, of the performance
obligations is a requirement (i.e., whether an entity needs to prove
that it does not meet the criteria in ASC 606-10-32-37 to allocate a
discount proportionately to all of the performance obligations).
We believe that if the criteria in ASC 606-10-32-37 are
met, an entity should allocate a discount to one or more, but not all,
of the performance obligations in a contract. We believe that failing to
do so would result in an allocation that is inconsistent with the core
allocation principle of ASC 606 — namely, that an entity should allocate
the transaction price to each performance obligation 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.
The level of effort required to determine whether the
criteria in ASC 606-10-32-37 are met will depend on the entity’s
specific facts and circumstances. Often, an entity’s established pricing
practice or customary business practices will provide sufficient
evidence that the criteria in ASC 606-10-32-37 are met (or not met).
However, in certain circumstances, it may not be evident that those
criteria are met (or not met), and an entity may therefore be required
to perform further analysis. Even so, we do not believe that an entity
must perform an exhaustive analysis to prove that the criteria in ASC
606-10-32-37 are not met before it can apply the general allocation
guidance in ASC 606-10-32-29 (i.e., allocate the discount
proportionately to the performance obligations).
However, in determining whether the criteria in ASC
606-10-32-37 are met, an entity should not ignore information that is
reasonably available without undue cost and effort. Entities may need to
document their pricing strategies for each good or service (which may be
part of the determination of stand-alone selling prices for each good or
service), including (1) how the goods or services are marketed, (2)
internally communicated pricing guidelines, (3) relative direct costs
attributed to goods or services, and (4) relevant market
information.
Entities may also need to assess their internal controls
to evaluate the manner in which they adhere to the requirement in ASC
606-10-32-37. An entity should develop a reasonable approach to
evaluating how discounts should be allocated, and it should apply that
approach consistently to similar contracts and in similar
circumstances.
7.4.2 Allocation of a Premium or Surplus
Entities often enter into arrangements for which the sum of the
stand-alone selling prices of the individual performance obligations exceeds the
transaction price. ASC 606-10-32-36 requires any discount under the contract to
be allocated proportionately to all performance obligations unless an entity has
observable evidence that the entire discount is related only to one or more, but
not all, of the performance obligations in the contract. ASC 606-10-32-37
specifies the criteria an entity must meet to conclude that the discount does
not need to be allocated proportionately to all performance obligations.
However, ASC 606 does not explicitly discuss situations in which
the transaction price exceeds the sum of the stand-alone selling prices of the
individual performance obligations, which would suggest that a customer is
paying a surplus or a premium for purchasing the goods or services.
Before assessing how to allocate a premium or surplus, given
that this scenario is expected to be relatively uncommon, an entity should
determine whether an apparent surplus indicates that an error, such as one of
the following, has been made in the analysis:
-
A significant financing component in the contract has not been identified.
-
The contract includes an incentive (i.e., performance bonus) that has not been identified or properly constrained.
-
Additional performance obligations have not been identified.
-
The stand-alone selling prices of performance obligations have not been correctly identified.
If, after further assessment, it is determined that a premium or
surplus exists, the entity should allocate that premium in a manner consistent
with the requirements of ASC 606 for allocation of a discount (i.e., on a
relative stand-alone selling price basis in accordance with ASC 606-10- 32-29,
subject to the exception in ASC 606-10-32-36 through 32-38).
7.5 Allocation of Variable Consideration
As discussed in Section 7.4, there may be instances in which applying the relative
stand-alone selling price allocation principle could result in the recognition of
revenue that does not depict the amount of consideration to which an entity expects
to be entitled in exchange for goods or services. This could occur when the criteria
for allocating a discount to one or more, but not all, performance obligations are
met. Another example is when a contract includes variable consideration and meets
certain criteria for allocating the variable consideration to one or more, but not
all, performance obligations or distinct goods or services. This additional
exception to the general allocation requirements is discussed in the following
paragraphs of ASC 606:
ASC 606-10
32-39 Variable consideration that
is promised in a contract may be attributable to the entire
contract or to a specific part of the contract, such as
either of the following:
-
One or more, but not all, performance obligations in the contract (for example, a bonus may be contingent on an entity transferring a promised good or service within a specified period of time)
-
One or more, but not all, distinct goods or services promised in a series of distinct goods or services that forms part of a single performance obligation in accordance with paragraph 606-10-25-14(b) (for example, the consideration promised for the second year of a two-year cleaning service contract will increase on the basis of movements in a specified inflation index).
32-40 An entity shall allocate a
variable amount (and subsequent changes to that amount)
entirely to a performance obligation or to a distinct good
or service that forms part of a single performance
obligation in accordance with paragraph 606-10-25-14(b) if
both of the following criteria are met:
-
The terms of a variable payment relate specifically to the entity’s efforts to satisfy the performance obligation or transfer the distinct good or service (or to a specific outcome from satisfying the performance obligation or transferring the distinct good or service).
-
Allocating the variable amount of consideration entirely to the performance obligation or the distinct good or service is consistent with the allocation objective in paragraph 606-10-32-28 when considering all of the performance obligations and payment terms in the contract.
32-41 The allocation requirements
in paragraphs 606-10-32-28 through 32-38 shall be applied to
allocate the remaining amount of the transaction price that
does not meet the criteria in paragraph 606-10-32-40.
7.5.1 Codification Example of Allocating Variable Consideration
The example below, which is reproduced from ASC 606, illustrates
how an entity would allocate variable consideration.
ASC 606-10
Example 35 — Allocation of Variable
Consideration
55-270 An entity enters into
a contract with a customer for two intellectual property
licenses (Licenses X and Y), which the entity determines
to represent two performance obligations each satisfied
at a point in time. The standalone selling prices of
Licenses X and Y are $800 and $1,000, respectively.
Case A — Variable Consideration
Allocated Entirely to One Performance
Obligation
55-271 The price stated in
the contract for License X is a fixed amount of $800,
and for License Y the consideration is 3 percent of the
customer’s future sales of products that use License Y.
For purposes of allocation, the entity estimates its
sales-based royalties (that is, the variable
consideration) to be $1,000, in accordance with
paragraph 606-10-32-8.
55-272 To allocate the
transaction price, the entity considers the criteria in
paragraph 606-10-32-40 and concludes that the variable
consideration (that is, the sales-based royalties)
should be allocated entirely to License Y. The entity
concludes that the criteria in paragraph 606-10-32-40
are met for the following reasons:
-
The variable payment relates specifically to an outcome from the performance obligation to transfer License Y (that is, the customer’s subsequent sales of products that use License Y).
-
Allocating the expected royalty amounts of $1,000 entirely to License Y is consistent with the allocation objective in paragraph 606-10-32-28. This is because the entity’s estimate of the amount of sales-based royalties ($1,000) approximates the standalone selling price of License Y and the fixed amount of $800 approximates the standalone selling price of License X. The entity allocates $800 to License X in accordance with paragraph 606-10-32-41. This is because, based on an assessment of the facts and circumstances relating to both licenses, allocating to License Y some of the fixed consideration in addition to all of the variable consideration would not meet the allocation objective in paragraph 606- 10-32-28.
55-273 The entity transfers
License Y at inception of the contract and transfers
License X one month later. Upon the transfer of License
Y, the entity does not recognize revenue because the
consideration allocated to License Y is in the form of a
sales-based royalty. Therefore, in accordance with
paragraph 606-10-55-65, the entity recognizes revenue
for the sales-based royalty when those subsequent sales
occur.
55-274 When License X is
transferred, the entity recognizes as revenue the $800
allocated to License X.
Case B — Variable Consideration
Allocated on the Basis of Standalone Selling
Prices
55-275 The price stated in
the contract for License X is a fixed amount of $300,
and for License Y the consideration is 5 percent of the
customer’s future sales of products that use License Y.
The entity’s estimate of the sales-based royalties (that
is, the variable consideration) is $1,500 in accordance
with paragraph 606-10-32-8.
55-276 To allocate the
transaction price, the entity applies the criteria in
paragraph 606-10-32-40 to determine whether to allocate
the variable consideration (that is, the sales-based
royalties) entirely to License Y. In applying the
criteria, the entity concludes that even though the
variable payments relate specifically to an outcome from
the performance obligation to transfer License Y (that
is, the customer’s subsequent sales of products that use
License Y), allocating the variable consideration
entirely to License Y would be inconsistent with the
principle for allocating the transaction price.
Allocating $300 to License X and $1,500 to License Y
does not reflect a reasonable allocation of the
transaction price on the basis of the standalone selling
prices of Licenses X and Y of $800 and $1,000,
respectively. Consequently, the entity applies the
general allocation requirements in paragraphs
606-10-32-31 through 32-35.
55-277 The entity allocates
the transaction price of $300 to Licenses X and Y on the
basis of relative standalone selling prices of $800 and
$1,000, respectively. The entity also allocates the
consideration related to the sales-based royalty on a
relative standalone selling price basis. However, in
accordance with paragraph 606-10-55-65, when an entity
licenses intellectual property in which the
consideration is in the form of a sales-based royalty,
the entity cannot recognize revenue until the later of
the following events: the subsequent sales occur or the
performance obligation is satisfied (or partially
satisfied).
55-278 License Y is
transferred to the customer at the inception of the
contract, and License X is transferred three months
later. When License Y is transferred, the entity
recognizes as revenue the $167 ($1,000 ÷ $1,800 × $300)
allocated to License Y. When License X is transferred,
the entity recognizes as revenue the $133 ($800 ÷ $1,800
× $300) allocated to License X.
55-279 In the first month,
the royalty due from the customer’s first month of sales
is $200. Consequently, in accordance with paragraph
606-10-55-65, the entity recognizes as revenue the $111
($1,000 ÷ $1,800 × $200) allocated to License Y (which
has been transferred to the customer and is therefore a
satisfied performance obligation). The entity recognizes
a contract liability for the $89 ($800 ÷ $1,800 × $200)
allocated to License X. This is because although the
subsequent sale by the entity’s customer has occurred,
the performance obligation to which the royalty has been
allocated has not been satisfied.
7.5.2 Allocating Variable Consideration and Discounts
In some circumstances, a contract may include both a discount
and variable consideration. The revenue standard includes guidance on allocating
discounts to only one or some, but not all, performance obligations, which
differs from the guidance on allocating variable consideration to one or some,
but not all, performance obligations or distinct goods or services. Because
discounts may be in the form of variable consideration (i.e., the revenue
standard cites discounts as examples of variable consideration), stakeholders
have questioned which guidance should be applied when an entity’s contract with
a customer includes a variable discount.
An entity would first determine whether a discount is variable
consideration. If the entity concludes that the discount is variable
consideration, it would apply the variable consideration allocation guidance in
ASC 606-10-32-39 through 32-41 if the related criteria are met and then apply
the allocation guidance in ASC 606-10-32-28 through 32-38 (which includes the
guidance on allocating discounts) to the remaining amount of the transaction
price. If the discount is not variable, the entity would look to the discount
allocation guidance to determine how to allocate the discount.
The above issue is addressed in Q&A 38 (compiled from
previously issued TRG Agenda Papers 31 and 34) of the FASB staff’s Revenue Recognition Implementation Q&As (the
“Implementation Q&As”). For additional information and Deloitte’s summary of
issues discussed in the Implementation Q&As, see Appendix C.
There are several approaches to determining the amount that represents a discount
rather than variable consideration. However, an entity should ensure that the
approach selected results in an allocation that is consistent with the criteria
in ASC 606-10-32-40, including the allocation objective in ASC 606-10-32-28.
The approaches are as follows:
- Approach 1 — An entity should determine the remaining discount, if any, that is a fixed discount (i.e., the amount of the discount that is present in the contract regardless of the outcome of the uncertainties that give rise to variable consideration). In determining the fixed discount in an arrangement, the entity should compare the combined stand-alone selling prices of the performance obligations with the sum of the fixed consideration and any potential variable consideration, including variable consideration that has been specifically allocated to a performance obligation. In determining potential variable consideration (i.e., the top end of the potential consideration), the entity should not include amounts that are not realistic outcomes (i.e., there should be substance to the potential variable consideration). Accordingly, when the likelihood of receiving certain amounts of variable consideration is sufficiently low, the entity should exclude those amounts from the transaction price when determining the portion of the discount that is essentially a fixed discount.
- Approach 2 — An entity should calculate the remaining discount by comparing the combined stand-alone selling prices of the performance obligations with the transaction price. The transaction price should include the fixed element plus an estimate of the variable consideration determined in accordance with ASC 606-10-32-8; that estimate should be made before the application of the constraints under ASC 606-10-32-11 or ASC 606-10-55-65.
- Approach 3 — An entity should calculate the remaining discount by comparing the combined stand-alone selling prices of the performance obligations with the transaction price. The transaction price should include the fixed element plus an estimate of the variable consideration determined in accordance with ASC 606-10-32-8, subject to the variable consideration constraints under ASC 606-10-32-11 or ASC 606-10-55-65.
The example below illustrates the application of the above
approaches.
Example 7-16
Consider the following:
-
An entity enters into a contract with a customer that includes Product A and Product B.
-
The stand-alone selling price of Product A is $100, and the stand-alone selling price of Product B is $200.
-
The contract includes fixed consideration of $225 and a performance bonus of $50 if certain conditions are met.
-
The performance bonus is related to the productivity enhancements that Product B achieves.
As indicated above, the contract
includes both a discount and variable consideration.
Because of the performance bonus, the determination of
the transaction price will result in either of the
following possible outcomes:
When a contract includes both a discount
and variable consideration, an entity would first apply
the variable consideration allocation guidance in ASC
606-10-32-39 through 32-41 to determine whether the
criteria for allocating the variable consideration to
one or more (but not all) of the performance obligations
are met. After considering the guidance on allocating
variable consideration, the entity would look to the
discount allocation guidance to determine how to
allocate the discount. ASC 606-10-32-41 establishes a
hierarchy that requires an entity to identify and
allocate variable consideration to performance
obligations before applying other guidance (e.g., the
guidance on allocating a discount).
Because the performance bonus is related
to productivity enhancements achieved by Product B, the
entity concludes that the criterion in ASC
606-10-32-40(a) is met and allocates the variable
consideration entirely to Product B. The entity would
then apply the guidance in ASC 606-10-32-28 through
32-38 to allocate the remaining consideration to Product
A and Product B. That allocation should be consistent
with the criterion in ASC 606-10-32-40(b).
Approach 1 would result in a fixed discount of $25 (i.e.,
the total stand-alone selling price of $300 minus the
total potential consideration of $275) that would be
allocated to Product A and Product B in accordance with
the guidance in ASC 606-10-32-36 through 32-38 as
follows:
Under Approach 1, $91.67 would be
recognized when control of Product A is transferred to
the customer. If the entity concludes that it is
probable that including the performance bonus in the
transaction price will not result in a significant
revenue reversal, the entity would recognize $183.33 as
revenue when control of Product B is transferred to the
customer. Any subsequent changes in the transaction
price would be attributed entirely to Product B.
Under Approach 2, if the amounts
discussed above are used across a portfolio of
homogeneous contracts and the entity estimates that it
would be entitled to a performance bonus of $40
(determined in accordance with ASC 606-10-32-8(a)), a
remaining discount of $35 (i.e., the total stand-alone
selling price of $300 minus the expected consideration
of $265) would be allocated to Product A and Product B
in accordance with the guidance in ASC 606-10-32-36
through 32-38 as follows:
Under Approach 2, $88.33 would be
recognized when control of Product A is transferred to
the customer. If the entity concludes that it is
probable that including the performance bonus in the
transaction price will not result in a significant
revenue reversal, the entity would recognize $186.67 as
revenue when control of Product B is transferred to the
customer. Any subsequent changes in the transaction
price would be attributed entirely to Product B.
Under Approach 3, if the amounts
discussed above are used across a portfolio of
homogeneous contracts and only $30 of the performance
bonus of $50 is included in the transaction price (i.e.,
the constrained amount of variable consideration), a
remaining discount of $45 (i.e., the total stand-alone
selling price of $300 minus the constrained transaction
price of $255) would be allocated to Product A and
Product B in accordance with the guidance in ASC
606-10-32-36 through 32-38 as follows:
Under Approach 3, $85 would be
recognized when control of Product A is transferred to
the customer. If the entity concludes that it is
probable that including the performance bonus in the
transaction price will not result in a significant
revenue reversal, the entity would recognize $190 as
revenue when control of Product B is transferred to the
customer. Any subsequent changes in the transaction
price would be attributed entirely to Product B.
The revenue standard does not prescribe a method for determining
the amount of remaining consideration to allocate once variable consideration
has been allocated in accordance with ASC 606-10-32-39 through 32-41. An entity
should use judgment and consider a contract’s specific facts and circumstances
when deciding which of the above approaches would best achieve the allocation
objective, which is to allocate the transaction price to each performance
obligation 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.
In the determination of which approach to use, it may be
relevant to consider whether the stand-alone selling price of one or more of the
goods or services is actually a range of amounts (which may be the case if
variable consideration is appropriately allocated to one or more, but not all,
performance obligations in a contract). For instance, if the stand-alone selling
price of B in the above example was determined to be between $150 and $200,
Approach 1 may be the most appropriate approach. This is because the discount
allocated to both A and B under either outcome results in an amount of revenue
recognized for each performance obligation that is (1) consistent with the
overall allocation objective and (2) based on the relative stand-alone selling
prices of A and B. Depending on the specific facts and circumstances, different
approaches may be more or less appropriate.
It will also be important to evaluate the potential outcomes of
any resulting allocation approach. For example, in situations involving both a
fixed discount and variable consideration (i.e., the total potential transaction
price is less than the aggregated stand-alone selling prices), we do not think
that an allocation that could result in the allocation of consideration to a
performance obligation in an amount that exceeds the performance obligation’s
stand-alone selling price would be consistent with the overall allocation
objective.
7.5.3 Allocating Variable Consideration to a Series of Distinct Services
|
The revenue standard includes a provision that requires
an entity to identify as a performance obligation a
promise to transfer a “series of distinct goods or
services that are substantially the same and that have
the same pattern of transfer to the customer” (see Section
5.3.3). As noted above, the revenue standard
requires the allocation of variable consideration to one
or more, but not all, of the distinct goods or services
promised in a series of distinct goods or services that
forms part of a single performance obligation in
accordance with ASC 606-10-25-14(b) (the “series
guidance”) when the criteria in ASC 606-10-32-40 are
met.
|
Stakeholders have questioned whether an entity is required to
allocate variable consideration on the basis of the relative stand-alone selling
price of each distinct good or service in a series accounted for as a single
performance obligation under ASC 606-10-25-14(b). If an entity is required to do
so, applying the series guidance would not result in the relief contemplated by
the FASB and IASB, as discussed in paragraph BC114 of ASU 2014-09. Such an
outcome would largely nullify the benefits of qualifying for the series guidance
since the same amount of consideration would most likely be allocated to each
distinct good or service that is “substantially the same” (because goods or
services that are substantially the same would most likely have the same
stand-alone selling prices). However, a distinct increment of service that forms
part of a single performance obligation may be substantially the same but have
varying stand-alone selling prices (see Section 5.3.3.1 on evaluating whether
distinct goods and services accounted for under the series guidance are
substantially the same), and allocating the variable consideration (or changes
in variable consideration) entirely to this discrete increment of service may be
consistent with the allocation objective in ASC 606-10-32-28.
As stated in ASC 606-10-32-29, the general allocation principle does not apply if
the criteria in ASC 606-10-32-39 through 32-41 are met. The FASB and IASB staffs
concluded that a relative stand-alone selling price allocation is not required
to meet the allocation objective when it is related to the allocation of
variable consideration to a distinct good or service in a series.
The application of this allocation concept is further explained in paragraph
BC285 of ASU 2014-09, which states, in part:
Consider the example of a
contract to provide hotel management services for one year (that is, a
single performance obligation in accordance with paragraph 606-10-25-14(b))
in which the consideration is variable and determined based on two percent
of occupancy rates. The entity provides a daily service of management that
is distinct, and the uncertainty related to the consideration also is
resolved on a daily basis when the occupancy occurs. In those circumstances,
the Boards did not intend for an entity to allocate the variable
consideration determined on a daily basis to the entire performance
obligation (that is, the promise to provide management services over a
one-year period). Instead, the variable consideration should be allocated to
the distinct service to which the variable consideration relates, which is
the daily management service.
The above example illustrates a scenario in which the same service (hotel
management) is performed each day for varying amounts (because occupancy rates
change each day). If it was determined that each day of service should have the
same stand-alone selling price, an entity might have to estimate the total
transaction price for the contract (on the basis of the expected occupancy rates
and associated fees over the term of the arrangement) and allocate that
transaction price to each distinct increment of service. However, as explained
in paragraph BC285, this was not the boards’ intent. Rather, variability in the
actual amounts earned each day based on occupancy rates can be allocated to that
day’s service without regard to a perceived stand-alone selling price of the
service provided. In all scenarios, however, the resulting allocation would need
to meet the overall allocation objective.
The guidance in ASC 606-10-32-39 through 32-41 specifically
addresses the allocation of variable consideration to one or more, but not all,
performance obligations (or distinct goods or services promised in a series) but
is silent on whether a similar allocation of fixed consideration is acceptable.
However, Example A of Implementation Q&A 45 (compiled from previously issued
TRG Agenda Papers 39 and 44) includes a declining fixed price per unit for variable
quantities. In that example, it would be acceptable to allocate the fixed price
attributed to each variable quantity even when the fixed price per unit declines
over time. This is because such consideration represents variable consideration
and doing so would meet the allocation objective when (1) the declining price is
intended to reflect changes in market terms or (2) the changes in price are
substantive and linked to changes in either the entity’s cost of fulfilling the
obligation or the value provided to the customer.
Although Example A illustrates a situation in which there is a
declining fixed unit price for variable quantities, we believe that the same
concepts apply to the allocation of fixed elements of consideration provided
that the contract also includes elements of variable consideration that meet the
criteria to be allocated to one or more, but not all, performance obligations.
That is, we believe that an entity must consider the total transaction price
(i.e., both fixed and variable components) when performing an evaluation under
ASC 606-10-32-40(b) to determine whether its application of the variable
consideration allocation guidance described in that subparagraph is consistent
with the overall allocation objective in ASC 606-10-32-28. Specifically, if the
fixed consideration declines over time, allocating less of the fixed
consideration to each successive period of a contract could be consistent with
the objective behind allocating the total transaction price (i.e., the overall
allocation objective in ASC 606-10-32-28) when (1) declining fixed consideration
is linked to changes in the entity’s cost of providing the service or changes in
the value provided to the customer and (2) the total transaction price also
includes elements of variable consideration that meet the criteria to be
allocated to one or more, but not all, distinct goods or services in a
series.
Example 7-17
Entity L enters into a contract to
provide 10 years of management service for an apartment
complex to Customer C. In exchange for the service
provided, C pays the following fees to L:
-
Base management fee — Fixed annual fee that declines by 1 percent each year as a result of expected efficiencies and other expected cost reductions.
-
Incentive fee — Variable annual fee based on 3 percent of C’s rental revenues.
-
Reimbursement — Payment of certain fulfillment costs incurred by L.
Entity L concludes that the management
service meets the criteria in ASC 606-10-25-15 to be
accounted for as a series of distinct services.
Under these facts, L can allocate the
fixed consideration in the contract to each distinct
increment of management service. The base management fee
declines on an annual basis as a result of expected
efficiencies and other expected cost reductions. In
addition, there are variable elements of consideration
that meet the criteria to be allocated to one or more,
but not all, distinct goods or services in a series. For
these reasons, we believe that L would meet the overall
allocation objective in ASC 606-10-32-28 by allocating
each annual amount of the base management fee, in
combination with the variable consideration (the annual
incentive fee, which is further discussed below), to a
distinct annual year of service. Consequently, L will
recognize less revenue from the base management fee in
each year of the contract.
Entity L can allocate the variable
consideration in the contract (i.e., the annual
incentive fee) to each distinct increment of management
service. The variable consideration in this example
(i.e., the annual incentive fee) is similar to the
variable payments in Example C of Implementation Q&A 45. The
variability associated with the incentive fee is
directly related to the distinct increments of
management service provided by L (i.e., the rental
income generated from the management service). Because
the variability is related to each distinct increment of
management service, allocating each annual incentive fee
to a distinct annual year of service is consistent with
the allocation objective in ASC 606-10-32-28.
Further, if the reimbursement of L’s
fulfillment costs is directly related to L’s efforts to
fulfill its promise to C, L can allocate that
reimbursement to the period in which the costs were
incurred. Doing so in that case would be consistent with
the allocation objective in ASC 606-10-32-28.
Connecting the Dots
The example above illustrates a situation in which a
single performance obligation results in multiple forms of consideration
(i.e., both fixed consideration and multiple sources of variable
consideration). As a result of the allocation conclusions above, the
actual revenue recognized is likely to fluctuate during the contract
period as the uncertainties associated with the sources of variable
consideration are resolved. Consequently, revenue might be recognized in
a pattern that suggests that multiple measures of progress are being
used to determine the entity’s pattern of performance. As discussed in
Section
8.5.3, an entity should use only a single measure of
progress for each performance obligation identified in a contract.
However, the pattern of revenue recognition that results from the
allocations described in the example above is not attributable to the
selection of multiple methods of measuring progress as part of step 5
(i.e., the pattern does not reflect multiple attribution). Rather, the
pattern arises from the application of the transaction price allocation
guidance as part of step 4.
7.5.3.1 Allocating Variable Consideration in Cloud-Based or Hosted Software Arrangements
Entities that sell cloud-based or hosted software solutions
(e.g., SaaS arrangements)6 often require the customer to pay them a variable amount, usually
based on the underlying usage of the SaaS technology. ASC 606 generally
requires entities to estimate variable consideration subject to a
constraint,7 but it also provides a practical expedient and a variable
consideration allocation exception. In addition, while ASC 606 includes an
exception to the general model for variable consideration in the form of a
sales- or usage-based royalty related to licenses of IP,8 SaaS arrangements often do not qualify for the exception because a
license is typically not transferred to the customer in such cases (i.e.,
the contracts are often hosting arrangements that do not meet the criteria
in ASC 985-20-15-5 to be considered a license and are therefore accounted
for as a service).
The next sections provide interpretive guidance intended to
help entities address certain challenges associated with applying the
revenue model in ASC 606 to SaaS arrangements that include variable
consideration. All of the examples assume that (1) SaaS is the only promise
in the contract and (2) the SaaS performance obligation meets the
requirements to be recognized over time because the customer “simultaneously
receives and consumes the benefits provided by the entity’s performance as
the entity performs,” in accordance with ASC 606-10-25-27(a).
7.5.3.1.1 Applying the Invoice Practical Expedient to Stand-Ready SaaS Arrangements With Usage-Based Variable Consideration
ASC 606-10-55-18 provides the following practical expedient (the “invoice
practical expedient”), which can be applied to performance obligations
that are satisfied over time:
As a practical expedient, if an entity has a right to
consideration from a customer in an amount that corresponds
directly with the value to the customer of the entity’s
performance completed to date (for example, a service contract
in which an entity bills a fixed amount for each hour of service
provided), the entity may recognize revenue in the amount to
which the entity has a right to invoice.
The invoice practical expedient allows an entity to recognize revenue in
the amount of consideration to which the entity has the right to invoice
if such amount corresponds directly to the value transferred to the
customer. That is, the invoice practical expedient cannot be applied in
all circumstances because the amount that an entity has the right to
invoice does not always correspond to the value of the entity’s
performance to date. Therefore, an entity should demonstrate its ability
to apply the invoice practical expedient to performance obligations
satisfied over time. In addition, because the use of the invoice
practical expedient must faithfully depict the entity’s measure of
progress toward completion, the expedient can only be applied to
performance obligations satisfied over time (not at a point in
time).
We believe that if a stand-ready SaaS arrangement (1) has a pricing
structure that is solely variable on the basis of the customer’s SaaS
usage, (2) is priced at the same fixed rate per usage, and (3) gives the
entity the right to invoice the customer for its usage as the usage
occurs, the invoice practical expedient may be applied. In such cases,
the amount of revenue for which the entity has the right to invoice may
reflect the value the customer has obtained from the SaaS during the
period because it is a fixed rate based on the volume of the customer’s
SaaS usage. Accordingly, an entity with this type of arrangement is not
required to estimate the amount of variable consideration to which it
would be entitled at contract inception and instead can recognize
revenue as the customer’s usage occurs (provided that it also has the
right to invoice).
The conclusion above may not be appropriate when (1) there are fixed fees
in addition to the usage-based fees, (2) there are substantive minimum
usage requirements, (3) the usage price or rate varies during the
contract period, or (4) up-front or back-end fees are charged. In those
circumstances, it may be challenging to demonstrate that the amount the
entity has the right to invoice corresponds to the value the customer
has received to date. However, the invoice practical expedient may not
necessarily be precluded in the following scenarios (not all-inclusive):
-
The amount of fixed consideration the entity has a right to invoice does not change from period to period, and the customer’s usage is expected to be consistent from period to period.
-
The customer is expected to significantly exceed any minimum usage requirements.
-
The usage rate changes solely on the basis of the Consumer Price Index or another metric that reflects an increase or decrease in value and directly correlates to the benefits received by the customer.
-
The up-front or back-end fees are insignificant relative to the other expected consideration in the arrangement so that the amount the entity has the right to invoice is commensurate with the value the customer has received to date.
7.5.3.1.2 Applying the Variable Consideration Allocation Exception to Stand-Ready SaaS Arrangements With Usage-Based Variable Consideration
Generally, ASC 606 requires an entity to allocate the transaction price
to each performance obligation on a relative stand-alone selling price
basis. However, the guidance provides an exception to the general
allocation principle that applies specifically to variable consideration
(the “variable consideration allocation exception”). Specifically, ASC
606-10-32-39(b) states that variable consideration may be attributable
to “[o]ne or more, but not all, distinct goods or services promised in a
series of distinct goods or services that forms part of a single
performance obligation.” In addition, ASC 606-10-32-40 states the
following:
An entity shall allocate a variable amount (and subsequent
changes to that amount) entirely to a performance obligation or
to a distinct good or service that forms part of a single
performance obligation in accordance with paragraph
606-10-25-14(b) if both of the following criteria are met:
- The terms of a variable payment relate specifically to the entity’s efforts to satisfy the performance obligation or transfer the distinct good or service (or to a specific outcome from satisfying the performance obligation or transferring the distinct good or service).
- Allocating the variable amount of consideration entirely to the performance obligation or the distinct good or service is consistent with the allocation objective in paragraph 606-10-32-28 when considering all of the performance obligations and payment terms in the contract.
If an entity elects not to apply the invoice practical
expedient or is precluded from applying such expedient to its
stand-ready SaaS arrangements, it may be required to apply the variable
consideration allocation exception to usage-based fees depending on the
facts and circumstances. Because a SaaS arrangement would typically be a
series of distinct services that represent a single performance
obligation, an entity that does not apply the invoice practical
expedient would apply the variable consideration allocation exception if
the conditions in ASC 606-10-32-40 are met. An entity that receives
variable consideration based on usage would typically meet the condition
in ASC 606-10-32-40(a) because the usage is usually associated with a
specific outcome (e.g., the transaction is processed, or storage
capacity is used). However, an entity must carefully evaluate its
pricing structure to determine whether allocating variable consideration
to a distinct service (e.g., each day that SaaS is provided) is
consistent with the allocation objective.
Example 7-18
Application of the Variable Consideration
Allocation Exception to Stand-Ready SaaS
Arrangements With Variable Consideration That Is
Solely Usage-Based
Entity A sells a SaaS platform
that is a stand-ready performance obligation. The
pricing structure for its SaaS is based solely on
usage (e.g., $1 for each transaction processed).
We believe that if a stand-ready SaaS arrangement
has a variable pricing structure based on the
customer’s SaaS usage and the SaaS is priced at a
fixed rate per usage, the variable consideration
allocation exception may be applied.9 This is because (1) the usage-based fees are
related to a specific outcome and (2) allocation
of the variable consideration to each distinct
service period (e.g., each day) would meet the
allocation objective (i.e., the usage-based
pricing represents the amount of consideration to
which the entity expects to be entitled upon the
transfer of each and every distinct service, which
is based on each increment of time within the
series). Accordingly, A is not required to
estimate the amount of variable consideration to
which it would be entitled at contract inception
and instead can recognize revenue as the
customer’s usage occurs.
However, the conclusion above may not be
appropriate if the usage price or rate varies
during the contract period, and an entity should
give careful consideration to variable fees that
increase or decrease on the basis of usage (e.g.,
tiered pricing). If the usage-based fees that
would be allocated to each distinct service would
not represent the amount of consideration to which
the entity expects to be entitled upon the
transfer of each distinct service (i.e., the
increase or decrease in the fee is not
commensurate with the efforts required by the
entity to satisfy each distinct service or does
not reflect the value of the specific outcome
associated with usage), it may not be appropriate
to conclude that the requirements to use the
variable consideration allocation exception are
met.
Example 7-19
Application of the Variable Consideration
Allocation Exception to Stand-Ready SaaS
Arrangements With Both Fixed Consideration and
Usage-Based Variable Consideration
Entity B sells a SaaS platform
that is a stand-ready performance obligation. The
pricing structure for its SaaS includes a fixed
component that is charged regardless of usage
(e.g., a flat fee of $100,000 for an annual
subscription) and a variable component based on
usage (e.g., $1 for each transaction processed).
If B uses a ratable (i.e., time-based) measure of
progress for its stand-ready SaaS arrangements,
the fixed consideration (e.g., $100,000) would be
recognized ratably over the contractual period. In
addition, as discussed in Example
7-18, we believe that if a stand-ready
SaaS arrangement has a variable pricing structure
based on the customer’s SaaS usage and the SaaS is
priced at a fixed rate per usage, the variable
consideration allocation exception may be applied.
This is because (1) the usage-based fees are
related to a specific outcome and (2) allocation
of the variable consideration to each distinct
service period (e.g., each day) would meet the
allocation objective (i.e., the usage-based
pricing would represent the amount of
consideration to which the entity expects to be
entitled upon the transfer of each and every
distinct service, which is based on each increment
of time within the series). Accordingly, B is not
required to estimate the amount of variable
consideration to which it would be entitled at
contract inception and instead can recognize the
variable consideration as the customer’s usage
occurs (with the fixed consideration recognized
ratably).
As in Example 7-18, the conclusion above may
not be appropriate if the usage price or rate
varies during the contract period.
Example 7-20
Application of the Variable Consideration
Allocation Exception to Stand-Ready SaaS
Arrangements With Overage Fees and Minimums That
Reset Monthly
Entity C sells a SaaS platform
that is a stand-ready performance obligation and
concludes that a ratable measure of progress for
the performance obligation is appropriate. The
pricing structure for its SaaS includes a fixed
component that is based on a predetermined amount
of usage (i.e., a minimum usage requirement) and a
variable component that is charged if the customer
exceeds the predetermined amount (i.e., “overage
fees”). In one of its arrangements, C sells a
one-year subscription that has a minimum usage
requirement of 100,000 transactions every month.
The subscription is priced at $100,000 per month
($1 for each transaction processed); if the number
of transactions exceeds 100,000, additional
transactions processed are also priced at $1 each.
If the customer has fewer than 100,000
transactions in any month, the shortfall is not
carried forward (e.g., if the customer only has
90,000 transactions in a particular month, it must
still pay $100,000 that month and the next month’s
minimum is still 100,000 transactions). Therefore,
the total fixed consideration is $1.2 million
($100,000 × 12 months), which is recognized
ratably over the contractual term.
An entity’s ability to apply the variable
consideration allocation exception when a fixed
component and overage fees exist depends on
whether the minimum usage requirements are the
same in each period, whether the overage fees are
a fixed rate per usage, and how often the minimum
usage requirements are “reset.” If the minimum
usage requirements are the same in each period,
overage fees are a fixed rate per usage, and
minimum usage requirements are reset frequently
throughout the entity’s reporting period (e.g.,
monthly), the overage fees incurred in such
periods typically qualify for the variable
consideration allocation exception. This is
because (1) the usage-based fees are related to a
specific outcome and (2) allocation of the
variable consideration to each distinct service
period (e.g., each month) would meet the
allocation objective (i.e., the usage-based
pricing represents the amount of consideration to
which the entity expects to be entitled upon the
transfer of each and every distinct service, which
is based on each increment of time within the
series).
In assessing the allocation objective, C
determines that any overage fees for a particular
month are solely associated with that month and
reflect the value of the specific outcome
associated with the overage. Accordingly, C is not
required to estimate the amount of variable
consideration to which it would be entitled at
contract inception and instead can recognize the
variable consideration as the customer’s usage
occurs (with the fixed consideration recognized
ratably).
Example 7-21
Application of the Variable Consideration
Allocation Exception to Stand-Ready SaaS
Arrangements With Overage Fees and a Minimum That
Does Not Reset
Assume the same facts as in
Example 7-20
except that in one of its arrangements, Entity C
sells a one-year subscription that has an annual
minimum usage requirement of 1.2 million
transactions. The subscription is priced at a
fixed fee of $1.2 million ($1 for each transaction
processed); if the number of transactions exceeds
1.2 million, additional transactions processed are
also priced at $1 each. Therefore, the total fixed
consideration is $1.2 million, which is recognized
ratably over the contractual term ($100,000 each
month).
Because the minimum usage requirements do not
reset, the overage fees incurred in the latter
part of the year would not qualify for the
variable consideration allocation exception. While
the usage-based fees are related to a specific
outcome, allocation of the variable consideration
to each distinct service period (e.g., the latter
month or months of the year) would not meet the
allocation objective (i.e., the usage-based
pricing does not represent the amount of
consideration to which the entity expects to be
entitled upon the transfer of each and every
distinct service, which is based on each increment
of time within the series). In assessing the
allocation objective, C determines that any
overage fees for a particular month (1) would not
be solely associated with that month and (2) would
not reflect the value of the specific outcome
associated with the overage. For example, if the
customer has 110,000 transactions in each month,
total consideration would be $1.32 million
(110,000 × $1 × 12 months) and $100,000 of fixed
consideration would be recognized in each month.
The overage fees would be $120,000 ($1.32 million
– $1.2 million). However, if the overage fees were
recognized in the specific month they related to,
they would be recognized in the last 2 months of
the year ($10,000 in month 11 and $110,000 in
month 12). Therefore, even though the number of
transactions would be the same in each month
(i.e., the benefits received in the last two
months are similar to those received in the first
10 months because the usage is the same), more
revenue would be recognized in the last 2 months
($100,000 recognized in months 1–10, $110,000
recognized in month 11, and $210,000 recognized in
month 12).
Example 7-22
Application of the Variable Consideration
Allocation Exception to Stand-Ready SaaS
Arrangements With Overage Fees and Minimums That
Reset Annually
Assume the same facts as in
Example 7-20
except that in one of its arrangements, Entity C
sells a three-year subscription that has an annual
minimum usage requirement of 1.2 million
transactions. The subscription is priced at $1.2
million per year ($1 for each transaction
processed); if the number of transactions exceeds
1.2 million, the additional transactions are also
priced at $1 each. If the customer has fewer than
1.2 million transactions in any year, the
shortfall is not carried forward (e.g., if the
customer only has 1 million transactions in a
particular year, it must still pay $1.2 million
and the next year’s minimum is still 1.2 million
transactions). Therefore, the total fixed
consideration is $3.6 million ($1.2 million × 3
years), which is recognized ratably over the
contractual term ($100,000 in each month).
Since the minimum usage requirements are the same
for each year, overage fees are a fixed rate per
usage, and minimum usage requirements are reset
each year, the overage fees incurred for a
particular annual period typically qualify for the
variable consideration allocation exception and
can therefore be allocated to that year’s service.
This is because (1) the usage-based fees are
related to a specific outcome and (2) the
allocation of variable consideration to each
distinct service period (e.g., each year) meets
the allocation objective (i.e., the usage-based
pricing represents the amount of consideration to
which the entity expects to be entitled upon the
transfer of each and every distinct service, which
is based on each annual increment of time within
the series). In assessing the allocation
objective, C determines that any overage fees for
a particular year are solely associated with that
year and reflect the value of the specific outcome
associated with the overage.
However, as in Example
7-21, because the minimum usage
requirements do not reset frequently (e.g.,
monthly), the overage fees incurred in the latter
part of each year would not qualify for the
variable consideration allocation exception for
the periods within each year (e.g., each month
within the year). While the usage-based fees are
related to a specific outcome, the allocation of
variable consideration to each distinct service
period (e.g., the latter month or months of the
year) would not meet the allocation objective
(i.e., the usage-based pricing does not represent
the amount of consideration to which the entity
expects to be entitled upon the transfer of each
and every distinct service, which is based on each
increment of time within the series). In assessing
the allocation objective, C determines that any
overage fees for a particular month (1) are not
solely associated with that month and (2) do not
reflect the value of the specific outcome
associated with the overage.
Accordingly, C would generally
be required to estimate the amount of variable
consideration to which it would be entitled in
each year and to recognize both fixed and variable
consideration ratably12 over each annual period, subject to the
variable consideration constraint. However,
because the allocation objective is met on an
annual basis (i.e., the overage fees for each year
(1) are solely associated with that year and (2)
reflect the value of the specific outcome
associated with the overage for that year), the
overages for a particular year can be recognized
that year. For example, if C expects $100,000 in
overage fees in the first year, $120,000 in
overage fees in the second year, and $150,000 in
overage fees in the third year, it may recognize
$1.3 million13 ratably in the first year, $1.32 million14 ratably in the second year, and $1.35
million15 ratably in the third year, subject to the
variable consideration constraint.16
Example 7-23
Application of the Variable Consideration
Allocation Exception to Stand-Ready SaaS
Arrangements With Overage Fees and Minimums That
Increase Monthly
Assume the same facts as in
Example 7-20 except that in one of its
arrangements, Entity C sells a one-year
subscription that has an increasing minimum usage
requirement in every month, which is priced at $1
for each transaction processed. If the number of
transactions exceeds the minimum requirement, the
additional transactions processed are also priced
at $1 each. The minimum usage starts at 100,000
transactions in the first month and increases by
10,000 in each month of the year (210,00017 in the last month). Therefore, the total
fixed consideration is $1.86 million,18 which is recognized ratably over the
contractual term.
Because the minimum usage
requirements change in each month, C must
carefully evaluate whether it would qualify for
the variable consideration allocation exception.
While the usage-based fees are related to a
specific outcome, allocation of the variable
consideration to each distinct service period
(e.g., each month) would not be likely to meet the
allocation objective (i.e., the usage-based
pricing is not likely to represent the amount of
consideration to which the entity expects to be
entitled upon the transfer of each and every
distinct service, which is based on each increment
of time within the series). In assessing the
allocation objective, C determines that any
overage fees for a particular month are not likely
to (1) be solely associated with that month or (2)
reflect the value of the specific outcome
associated with the overage. For example, fixed
consideration of $155,000 would be recognized in
each month ($1.86 million ÷ 12 months). However,
if the customer had 200,000 transactions in each
month, the amount of overage fees would be greater
in the earlier months ($100,00019 in the first month, $90,00020 in the second month, and so on). Therefore,
even though the number of transactions would be
the same in each month, more consideration would
be recognized in the earlier months (for a total
of $255,00021 recognized in the first month, $245,00022 recognized in the second month, and so
on).
Example 7-23A
Application of the Variable Consideration
Allocation Exception to Stand-Ready SaaS
Arrangements With Overage Fees and Minimums That
Increase Monthly — Nonsubstantive Minimums
Assume the same facts as in Example 7-23 except
that Entity C expects that the customer will
exceed the monthly minimum each month of the
contract. Entity C concludes that the monthly
minimum is not substantive and that therefore,
both fixed consideration and variable
consideration are in-substance variable
consideration.
In a manner similar to our views
in Example 7-18, we
believe that if a stand-ready SaaS arrangement has
a variable pricing structure based on the
customer’s SaaS usage and the SaaS is priced at a
fixed rate per usage, the variable consideration
allocation exception may be applied when fixed
monthly minimums are not substantive (i.e., are
expected to be exceeded each month).25 In assessing the allocation objective, C
determines that any consideration (including both
monthly minimums and overages) for a particular
month is solely associated with that month and
reflects the value of the specific outcome
associated with the monthly minimum and overage
fees.
Accordingly, C is not required to estimate the
amount of variable consideration to which it would
be entitled at contract inception and instead can
recognize revenue related to both fixed and
variable consideration as the customer’s usage
occurs.
Example 7-24
Application of the Variable Consideration
Allocation Exception to Stand-Ready SaaS
Arrangements With Overage Fees and Minimums That
Carry Over
Assume the same facts as in
Example 7-20
except that in one of its arrangements, Entity C
sells a one-year subscription that specifies a
minimum usage requirement of 100,000 transactions
in every month. The subscription is priced at
$100,000 per month ($1 for each transaction
processed); if the number of transactions exceeds
100,000, the additional transactions processed are
also priced at $1 each. However, if the customer
has fewer than 100,000 transactions in any month,
the shortfall is carried over to the following
month (e.g., if the customer only has 90,000
transactions in the first month, it must still pay
$100,000 for that month but the next month’s
minimum becomes 110,000 transactions; and if in
the second month the customer only has 95,000
transactions, it must still pay $100,000 for that
month but the next month’s minimum becomes
115,000. However, if in the third month the
customer has 120,000 transactions, it will pay
$100,000 for that month and pay $5,000 for the
overage). In addition, any shortfall at the end of
the year is not carried forward upon renewal.
Therefore, the total fixed consideration is $1.2
million ($100,000 × 12 months), which is
recognized ratably over the contractual term.
Because the minimum usage
requirements could change in each month, C must
carefully evaluate whether it would qualify for
the variable consideration allocation exception.
As in Example 7-23,
while the usage-based fees are related to a
specific outcome, allocation of the variable
consideration to each distinct service period
(e.g., each month) may not meet the allocation
objective (i.e., the usage-based pricing may not
represent the amount of consideration to which the
entity expects to be entitled upon the transfer of
each and every distinct service, which is based on
each increment of time within the series).
Therefore, if the minimum usage requirements
change monthly, any overage fees for a particular
month may not (1) be solely associated with that
month or (2) reflect the value of the specific
outcome associated with the overage. Accordingly,
C may be required to estimate the amount of
variable consideration to which it would be
entitled at contract inception and to recognize
both fixed and variable consideration ratably over
the contract term, subject to the variable
consideration constraint.
However, if C expects the
customer to exceed 100,000 transactions in every
month (i.e., there is no shortfall carried over),
the arrangement may be similar to that in
Example 7-20, and any overage fees for
a particular month would (1) be solely associated
with that month and (2) reflect the value of the
specific outcome associated with the overage. In
that case, C would not be required to estimate the
amount of variable consideration to which it would
be entitled at contract inception and instead
could recognize the variable consideration as the
customer’s usage occurs (with the fixed
consideration recognized ratably).26
7.5.4 Optional Exemption From Disclosure Requirement
Stakeholders have raised concerns regarding the need to disclose
the amount of the transaction price that is allocated to remaining performance
obligations when (1) the remaining performance obligations form part of a
series, (2) the transaction price includes an amount of variable consideration,
and (3) the entity meets the criteria in ASC 606-10-32-40 for allocating the
variable amount entirely to a distinct good or service that forms part of a
single performance obligation. In these situations, an entity may be required to
estimate the amount of variable consideration to include in the transaction
price only for disclosure purposes. That is because any remaining variability in
the transaction price would be related entirely to unsatisfied portions of a
single performance obligation.
ASU
2016-20 includes the addition of an optional exemption to
the revenue standard’s guidance on required disclosures. The optional exemption
provides relief from the requirement to disclose the amount of variable
consideration included in the transaction price that is allocated to outstanding
performance obligations when either of the following conditions is met:
- The variability is related to a sales- or usage-based royalty.
- The variable consideration is allocated entirely to unsatisfied performance obligations or to a wholly unsatisfied promise to transfer a distinct good or service that forms part of a single performance obligation for which the criteria in ASC 606-10-32-40 are met.
Entities electing the optional exemption are still required to
disclose any fixed consideration allocated to outstanding performance
obligations.
7.5.5 Application of the Variable Consideration Allocation Exception to Commodity Sales Contracts With Market- or Index-Based Pricing
Entities in commodity industries (e.g., oil and gas, power and
utilities, mining and metals, and agriculture) may enter into sales contracts to
transfer a specified quantity of commodities in exchange for market- or
index-based pricing at the time the commodities are transferred.
Commodity sales contracts with market- or index-based pricing
contain variable consideration since the ultimate amount to which entities in
such contracts are entitled is unknown at contract inception. Consequently,
entities that have entered into these contracts should evaluate the criteria in
ASC 606-10-32-40 to determine whether the variable consideration allocation
exception is met.
Generally, commodity sales contracts that contain only market-
or index-based pricing will meet the criteria in ASC 606-10-32-40, and therefore
qualify for the variable consideration allocation exception, as follows:
- The criterion in ASC 606-10-32-40(a) will generally be met because the variability is solely attributed to, and resolved as a result of, the market- or index-based price upon the transfer of each distinct commodity to the customer.
- The criterion in ASC 606-10-32-40(b) will generally be met because the market- or index-based price represents the amount of consideration to which the entity expects to be entitled upon the transfer of each distinct commodity. If the index-based price is unrelated to the commodity (e.g., oil indexed to inflation), the criterion in ASC 606-10-32-40(b) may not be met.
However, when commodity sales contracts with market- or
index-based pricing also include fixed consideration or other types of variable
consideration, entities will need to consider all of the payment terms to
determine whether both of the criteria in ASC 606-10-32-40 are met.
Example 7-25
Company T enters into a contract with a
customer to sell and deliver specified gallons of
heating oil each day over a two-year period. The price
of the heating oil is based on the New York Harbor No. 2
Heating Oil Spot Price (the “Pricing Index”) on the day
that the heating oil is delivered to the customer.
Company T concludes that each gallon of
heating oil represents a separate performance obligation
(i.e., a distinct good). That is, each gallon of heating
oil is separately identifiable and capable of benefiting
the customer on its own. In addition, control of each
gallon of heating oil is transferred at the time of
delivery (i.e., at a point in time).
Because of the variable consideration in
the contract that arises from the Pricing Index, T
evaluates whether the contract meets the criteria in ASC
606-10-32-40 and therefore qualifies for the variable
consideration allocation exception. In its evaluation, T
makes the following determinations:
-
The criterion in ASC 606-10-32-40(a) is met because the daily Pricing Index (i.e., the variable consideration) is specifically related to T’s efforts to transfer the distinct goods each day (i.e., each daily quantity of heating oil).
-
The criterion in ASC 606-10-32-40(b) is met because the Pricing Index reflects the amount of consideration to which T expects to be entitled upon the transfer of the distinct goods (i.e., each daily quantity of heating oil).
On the basis of these determinations, T
concludes that it is appropriate to recognize revenue in
an amount equal to the gallons of heating oil each day
multiplied by the Pricing Index on the day the oil is
delivered to the customer.
7.5.6 Accounting for Sponsorship Arrangements
Companies often enter into multiyear sponsorship arrangements
with venues (e.g., sports stadiums) to promote their brand. For example, a beer
company may enter into a contract with a football stadium to display its logo on
the football field. Other examples of sponsorship arrangements include
companies’ obtaining the naming rights to stadiums.
Many sponsorship arrangements are relatively long-term (e.g.,
five years or longer) and may contain stated price increases on an annual basis
(e.g., 3 percent increase in the annual fee each year of the contract). The
example below illustrates these concepts.
Example 7-26
Chi Corp. owns an arena, which is used
by a baseball team, the Streeterville Sluggers, to play
its home games from April to October each year. In
addition to baseball games, the arena holds other live
events (e.g., concerts) that occur evenly throughout the
year. The Streeterville Sluggers games constitute
approximately 40 percent of the total live events held
at the arena throughout the year. The number of other
live events is subject to the duration of the team’s
season (e.g., the team’s season will be longer if the
team makes it into the playoffs).
On January 1, 20X8, Chi Corp. enters
into a five-year noncancelable sponsorship agreement
with Beer Inc., which allows Beer Inc.’s logo to be
displayed throughout the arena. Chi Corp.’s promise to
provide the sponsorship rights meets the criteria in ASC
606-10-25-27 to be satisfied over time.
Chi Corp. has concluded that the
contract to provide sponsorship rights to Beer Inc. does
not contain a lease under ASC 842.
In exchange for the sponsorship rights
granted to Beer Inc., Beer Inc. agrees to pay Chi Corp.
a fixed fee that increases by 5 percent each year as
follows:
-
Year 1: $1,000,000
-
Year 2: $1,050,000
-
Year 3: $1,102,500
-
Year 4: $1,157,625
-
Year 5: $1,215,506
Chi Corp. has concluded that the annual
fees stated in the contract are equal to the stand-alone
selling price of the services provided in each annual
period of the sponsorship. In addition, Chi Corp. has
concluded that it does not meet the conditions in ASC
606-10-55-18 to apply the invoice practical expedient
(see Section 8.5.8.1 for further discussion
of the invoice practical expedient).
When assessing how to allocate the
annual fees and recognize revenue, Chi Corp. must first
evaluate the criteria in ASC 606-10-25-14(b) and 25-15
to determine whether the annual sponsorship rights it
promised in a long-term sponsorship arrangement
represent a series of distinct licenses (and therefore a
single performance obligation) or multiple performance
obligations (i.e., separate performance obligations for
each annual period).
ASC 606-10-25-14(b) states that a series
consists of “distinct goods or services that are
substantially the same and that have the same pattern of
transfer to the customer.” Further, ASC 606-10-25-15
provides the following two criteria that, if met, would
establish that a series of distinct goods or services
has the same pattern of transfer to the customer:
-
“Each distinct good or service in the series that the entity promises to transfer to the customer would meet the criteria in paragraph 606-10-25-27 to be a performance obligation satisfied over time.”
-
The “same method would be used to measure the entity’s progress toward complete satisfaction of the performance obligation to transfer each distinct good or service in the series to the customer.”
When assessing the criteria in ASC
606-10-25-14(b) and 25-15, Chi Corp. should evaluate the
nature of its promise in the sponsorship arrangement
and, more specifically, should consider whether the
nature of its promise varies throughout the contract
term (i.e., whether the promise in one annual period is
substantially the same as the promise in other annual
periods of the contract term).
If Chi Corp. concludes that the nature
of its promise in the sponsorship arrangement is
substantially the same in each year of the contract, the
promise to provide sponsorship rights over the contract
term would meet the criteria in ASC 606-10-25-14(b) and
25-15 to be accounted for as a series of distinct
licenses, which are accounted for as a single
performance obligation. Although the single performance
obligation would consist of a series of distinct
licenses, Chi Corp. concludes that it does not meet the
criteria in ASC 606-10-32-40 to allocate consideration
entirely to one or more, but not all, of the distinct
periods within the series because no element of variable
consideration exists. Therefore, Chi Corp. would
recognize the transaction price (i.e., $5,525,631) by
using a single measure of progress over the five-year
contract term (e.g., ratably if Chi Corp. determines
that time is an appropriate measure of progress).
Recognizing revenue by using a time-based measure of
progress would result in the creation of a contract
asset in year 1, which would increase in years 2 and 3
of the contract and subsequently reverse in years 4 and
5 of the contract.
If, on the other hand, Chi Corp.
concludes that the nature of its promise in the
sponsorship arrangement is not substantially the same in
each year of the contract, the promise to provide
sponsorship rights over the contract term would not meet
the criteria in ASC 606-10-25-14(b) and 25-15 to be
accounted for as a series of distinct licenses. Rather,
the contract would consist of five distinct performance
obligations since the events occur evenly throughout the
year (i.e., a distinct performance obligation for each
annual period of the contract). Because the annual fees
stated in the contract are equal to the stand-alone
selling price of the services provided in each annual
period of the sponsorship, Chi Corp. would allocate the
stated annual fees in the contract to each annual
period. Consequently, Chi Corp. would recognize revenue
for each annual period equal to the amount billed to
Beer Inc. for that period.
Footnotes
6
In this section, it is assumed that a SaaS
arrangement is accounted for as a service contract because the
customer does not have the ability to take possession of the
underlying software license on an on-premise basis.
7
In accordance with ASC 606-10-32-11, variable
consideration can only be included in the transaction price “to the
extent that it is probable that a significant reversal in the amount
of cumulative revenue recognized will not occur when the uncertainty
associated with the variable consideration is subsequently
resolved.”
8
When a sales- or usage-based royalty is related to
only a license of IP or to a license of IP that is the predominant
item in an arrangement, the royalty is recognized at the later of
the date on which (1) the subsequent sale or usage occurs or (2) the
performance obligation associated with the royalty is satisfied (or
partially satisfied).
9
This assumes that the invoice
practical expedient is not used. However, as
discussed in Section
7.5.3.1.1, the invoice practical
expedient could be used when a stand-ready SaaS
arrangement (1) has a pricing structure that is
solely variable on the basis of the customer’s
SaaS usage, (2) is priced at a fixed rate per
usage, and (3) gives the entity the right to
invoice the customer for its usage as the usage
occurs.
10
Since the ratable recognition
of variable consideration might result in a
contract asset, C should ensure that no separate
buying decisions or optional purchases are giving
rise to that variability so that it has
enforceable rights to such consideration.
11
However, as discussed in
Section 7.5.3.1.1, the invoice
practical expedient could be used when a
stand-ready SaaS arrangement (1) has a pricing
structure that is solely variable on the basis of
the customer’s SaaS usage, (2) is priced at a
fixed rate per usage, and (3) gives the entity the
right to invoice the customer for its usage as the
usage occurs. While, in this example, the fees are
not solely variable, if (1) the customer is
expected to significantly exceed the minimum usage
requirements, (2) the minimum usage is priced at
the same rate as any overages, and (3) C has the
right to invoice the customer for its usage as the
usage occurs, C may be able to use the invoice
practical expedient (which would result in the
recognition of both the fixed and variable fees as
usage occurs rather than ratable recognition).
12
See footnote 10.
13
$1.2 million fixed
consideration plus $100,000 estimated variable
consideration.
14
$1.2 million fixed
consideration plus $120,000 estimated variable
consideration.
15
$1.2 million fixed
consideration plus $150,000 estimated variable
consideration.
16
To determine whether the
invoice practical expedient can be used, see
footnote 11.
17
$100,000 plus ($10,000 × 11
months).
18
$100,000 + $110,000 + $120,000
+ $130,000 + $140,000 + $150,000 + $160,000 +
$170,000 + $180,000 + $190,000 + $200,000 +
$210,000.
19
$200,000 total fees (200,000
transactions × $1 per transaction) less $100,000
minimum in month 1.
20
$200,000 total fees (200,000
transactions × $1 per transaction) less $110,000
minimum in month 2.
21
$155,000 fixed consideration
plus $100,000 overage fees (see footnote 19).
22
$155,000 fixed consideration
plus $90,000 overage fees (see footnote 20).
23
See footnote 10.
24
To determine whether the
invoice practical expedient can be used, see
footnote 11.
25
To determine whether the
invoice practical expedient can be used, see
footnote 11.
26
To determine whether the
invoice practical expedient can be used, see
footnote 11.
7.6 Changes in the Transaction Price
7.6.1 Allocating Changes in the Transaction Price
ASC 606-10
32-42 After contract inception,
the transaction price can change for various reasons,
including the resolution of uncertain events or other
changes in circumstances that change the amount of
consideration to which an entity expects to be entitled
in exchange for the promised goods or services.
32-43 An entity shall allocate
to the performance obligations in the contract any
subsequent changes in the transaction price on the same
basis as at contract inception. Consequently, an entity
shall not reallocate the transaction price to reflect
changes in standalone selling prices after contract
inception. Amounts allocated to a satisfied performance
obligation shall be recognized as revenue, or as a
reduction of revenue, in the period in which the
transaction price changes.
32-44 An entity shall allocate
a change in the transaction price entirely to one or
more, but not all, performance obligations or distinct
goods or services promised in a series that forms part
of a single performance obligation in accordance with
paragraph 606-10-25-14(b) only if the criteria in
paragraph 606-10- 32-40 on allocating variable
consideration are met.
32-45 An entity shall account
for a change in the transaction price that arises as a
result of a contract modification in accordance with
paragraphs 606-10-25-10 through 25-13. However, for a
change in the transaction price that occurs after a
contract modification, an entity shall apply paragraphs
606-10-32-42 through 32-44 to allocate the change in the
transaction price in whichever of the following ways is
applicable:
-
An entity shall allocate the change in the transaction price to the performance obligations identified in the contract before the modification if, and to the extent that, the change in the transaction price is attributable to an amount of variable consideration promised before the modification and the modification is accounted for in accordance with paragraph 606-10-25-13(a).
-
In all other cases in which the modification was not accounted for as a separate contract in accordance with paragraph 606-10-25-12, an entity shall allocate the change in the transaction price to the performance obligations in the modified contract (that is, the performance obligations that were unsatisfied or partially unsatisfied immediately after the modification).
As discussed in Chapter 6, an entity needs to determine a contract’s transaction
price so that it can be allocated to the performance obligations in the
contract. This determination is made at contract inception. However, after
contract inception, the transaction price could change for various reasons
(e.g., changes in an estimate of variable consideration). Generally, any change
in the transaction price should be allocated to the performance obligations on
the same basis used at contract inception. For example, if the criteria for
allocating variable consideration to one or more, but not all, performance
obligations are met, changes in the amount of variable consideration to which
the entity expects to be entitled would be allocated to such performance
obligation(s) on the same basis. If the criteria for allocating variable
consideration to one or more, but not all, performance obligations are not met,
changes in the transaction price after contract inception would be allocated to
all of the performance obligations in the contract on the basis of the initial
relative stand-alone selling prices. An entity would not reallocate the
transaction price for changes in stand-alone selling prices after contract
inception.
For changes in the transaction price that arise as a result of a
contract modification, an entity should apply the guidance on contract
modifications in ASC 606-10-25-10 through 25-13 (see Section 9.4). However, if the transaction
price changes after a contract modification, an entity would allocate the change
as follows:
-
The change in the transaction price is allocated to a performance obligation that was identified before the contract modification when (1) the change in the transaction price is attributable to variable consideration related to that performance obligation and (2) the contract modification is accounted for as if the contract was terminated and a new contract was entered into (see ASC 606-10-25-13(a)).
-
In all other situations, the change in the transaction price is allocated to the unsatisfied or partially satisfied performance obligations that are identified after the contract modification.
7.6.2 Differentiating Changes in the Transaction Price From Contract Modifications
ASC 606-10-32-43 and 32-44 specify that an entity should
allocate changes in the transaction price on the same basis as at contract
inception. Application of this guidance may result in a cumulative catch-up
adjustment to revenue for amounts allocated to satisfied performance
obligations. In addition, ASC 606-10-32-45 states that an entity should account
for changes in the transaction price that are triggered by a contract
modification in accordance with the contract modification guidance in ASC
606-10-25-10 through 25-13.
An entity should consider whether the change in the price is due
to (1) the resolution of variability that existed at contract inception or (2) a
change in the scope or price (or both) of the contract that changes the parties’
rights and obligations after contract inception.
ASC 606-10-32-42 describes a change in the transaction price as
the “resolution of uncertain events or other changes in circumstances that
change the amount of consideration to which an entity expects to be entitled in
exchange for the promised goods or services.” A change in the transaction price
could result from the resolution of variable consideration (e.g., achieving a
performance bonus or qualifying for a volume rebate) that was part of the
contract at inception. However, the contract does not always have to
specifically identify forms of variable consideration for subsequent changes to
be accounted for as a change in the transaction price. The following factors
could suggest that subsequent changes in the transaction price do not constitute
a contract modification:
-
The entity has a history of granting price concessions to customers, which may or may not have been specifically negotiated.
-
The selling prices of the goods or services are highly variable, and the entity has a demonstrated history of not enforcing payment of the stated sales price (e.g., the entity has granted extended payment terms and has a history of not enforcing payment of the full contract price).
-
Changes in the transaction price result from customer satisfaction issues related to the underlying product or service.
On the other hand, a contract modification is described in ASC
606-10-25-10 as “a change in the scope or price (or both) of a contract that is
approved by the parties to the contract. . . . A contract modification exists
when the parties to a contract approve a modification that either creates new or
changes existing enforceable rights and obligations of the parties to the
contract.” Although contract modifications will usually result from negotiations
between the parties after contract inception, finalizing the amount of
concessions or other variable consideration may also require subsequent
negotiations between the parties. Therefore, the existence of negotiations is
not in itself determinative of whether a change represents a change in the
transaction price or a contract modification. Further, while contract
modifications often include the addition or removal of goods or services, they
could occasionally occur without a change in the scope of the contract (i.e.,
only as a result of a change in price). The following factors could suggest that
a change in the transaction price should be accounted for as a modification:
-
Subsequent changes in market conditions suggest that there has been a substantial change in the market price of the goods or services that was not anticipated at contract inception, which resulted in the entity’s agreeing to adjust the transaction price.
-
The entity has no history of granting price concessions, and the price concession is not related to the quality of the transferred goods or services.
-
The entity agreed to a reduction in the transaction price for remaining goods or services to induce its customer to enter into a contract for additional goods or services.
-
Technological advances and competitive pressures that did not exist at contract inception result in a significant change in the price that the entity is willing to accept for its goods or services.
An entity will need to use judgment to determine whether a
change in price is the result of a change in the transaction price or a contract
modification, especially when the entity provides the customer with a price
concession. In situations involving a price concession, an entity will need to
consider whether the price concession should have been contemplated at contract
inception and thus represents a change in the transaction price. As illustrated
in Example 5, Case B, of the revenue standard (ASC 606-10-55-114 through
55-116), this may be the case when the concession is related to product defects
or service issues associated with products or services that have already been
transferred to the customer. Had the product defects or service issues been
anticipated at contract inception, the potential price concession would have
been identified as a source of variable consideration under the contract.
Alternatively, a concession may result from a change in market
conditions that could not have been anticipated at contract inception. The
resulting change in the price of the contract changes the existing enforceable
rights and obligations of the parties under the contract and should be accounted
for as a contract modification in accordance with ASC 606-10-25-10 through
25-13.
The example below illustrates the identification of and
accounting for a change in the transaction price that results from a contract
modification.
Example 7-27
Albus Inc. enters into a contract with
Cherry Co. to deliver 120 standard widgets (each
distinct) over a 12-month period for a fixed price of
$100 per widget (total transaction price of $12,000).
After 60 widgets are transferred (for which Albus Inc.
recognizes $6,000 in revenue), a new competitor launches
a competing product that is being sold for $65 per
widget. Because of a change in the competitive landscape
and to preserve its customer relationship, Albus Inc.
agrees to lower the price for the remaining 60 widgets
to $60 per unit.
Albus Inc. concludes that (1) its rights
under the initial contract changed (having given up its
right to $100 per widget) and (2) it should account for
the change in the transaction price as a contract
modification. Consequently, Albus Inc. applies the
guidance in ASC 606-10-25-10 through 25-13. Since the
remaining widgets to be transferred under the contract
are distinct, Albus Inc. will recognize revenue of
$3,600 ($60 × 60 units) as the remaining 60 widgets are
transferred to Cherry Co.
In contrast to the example above, the example below illustrates
the identification of and accounting for a change in the transaction price that
does not result from a contract modification.
Example 7-28
Albus Inc. enters into a contract with
Cherry Co. to deliver 120 standard widgets (each
distinct) over a 12-month period for a fixed price of
$100 per widget (total transaction price of $12,000).
After 60 widgets are delivered, Cherry Co. identifies
quality issues with the first 60 units delivered that
require a small amount of rework. After negotiations,
Albus Inc. agrees to grant Cherry Co. a concession of
$20 per unit (a total concession of $2,400). Albus Inc.
and Cherry Co. agree that the concession will be
reflected in the selling price of the remaining 60
widgets (decreasing the price to $60 per widget for the
remaining 60 widgets).
Albus Inc. determines that it should
account for the concession as a change in the
transaction price since it resulted from conditions that
existed in the initial contract (quality issues in the
transferred widgets).That is, because of the quality
issue in the product (which will continue with the
remaining widgets), Albus Inc. concludes that it had a
right to consideration of only $80 per widget under the
initial contract. Consequently, Albus Inc. applies the
guidance in ASC 606-10-32-43 and 32-44. It records an
immediate adjustment to revenue of $1,200 for the $20
per widget concession granted for units already
transferred to Cherry Co. and will recognize revenue of
$4,800 ($80 per widget) as the remaining 60 widgets are
transferred to Cherry Co.
Refer to Chapter 9 for additional information about accounting for
contract modifications.
7.7 Allocation Considerations for Significant Financing Components
Under step 3 of ASC 606’s revenue recognition model, an entity may
need to adjust its transaction price for the existence of a significant financing
component (see Section 6.4).
ASC 606-10-32-15 requires an entity to adjust the transaction price for the effects
of the time value of money if the timing of payments agreed to by the parties to the
contract provides the customer or the entity with a significant benefit of financing
the transfer of goods or services to the customer (see Section 6.3). In those circumstances, the contract contains a
significant financing component.
In situations involving a contract with a customer that includes multiple performance
obligations, questions have arisen about whether an adjustment to the transaction
price resulting from a significant financing arrangement could be allocated to one
or more, but not all, performance obligations.
Generally, a significant financing component in a contract is
related to the contract as a whole rather than to the individual performance
obligations in the contract. However, it may be reasonable in some circumstances to
allocate a significant financing component to one or more, but not all, of the
performance obligations in the contract. As a practical matter, when an entity
considers the basis for such allocation, it may be appropriate for the entity to
analogize to (1) the guidance in ASC 606-10-32-36 through 32-38 on allocating a
discount or (2) the guidance in ASC 606-10-32-39 through 32-41 on allocating
variable consideration.
An entity that is considering the possibility of allocating a
significant financing component to one or more, but not all, of the performance
obligations in a contract will need to use judgment in determining whether such an
approach is reasonable in the particular circumstances of that contract.
The above issue is addressed in Implementation Q&A 37 (compiled from previously issued
TRG Agenda Papers 30 and 34). For additional information and Deloitte’s summary of
issues discussed in the Implementation Q&As, see Appendix C.