Solving the Revenue Recognition Maze: Step 4, Allocating the Transaction Price

Step 4 of Revenue Recognition: Allocate the Transaction Price

According to the Financial Accounting Standards Board’s (FASB’s) Revenue from Contracts with Customers (referred to hereafter as “the standard”), there are five steps to revenue recognition. In this article, we discuss the fourth step of recognizing revenue: allocating transaction price.

Transaction Price Allocation “Forks” in the Maze

In this step, the transaction price determined in step three is allocated among the performance obligations identified in step two. Allocation is based on the prices charged for goods and services when they are sold separately (i.e., “standalone” prices). If performance obligations are “packaged” and do not have standalone prices, then allocation amounts should be estimated using one of the following:

  • market prices,
  • cost plus expected margin, or
  • “residual” prices (i.e., package price minus the sum of other obligations that do have standalone prices).

The standard notes that the residual method is a “last resort” and should be used only if standalone prices are highly variable (i.e., large numbers of the same product or service are sold to different customers at different prices) or simply unknown (i.e., either a price hasn’t been established or the good or service has never been sold on a standalone basis). Intellectual property sales, for example, may fit this profile.

Retracing Steps to Offer Discounts

Companies should consider their histories of offering discounts when allocating transaction prices for bundled goods and services. It may not always be appropriate to allocate a proportional share of the discount to every item in the bundle. For instance, a retailer sells a bicycle, helmet, and pump for $350. Normally, the bike sells for $325, the helmet sells for $30, and the pump sells for $20. Thus, the bundle discount is $25. The bike and helmet often sell in bundled promotions, but the pumps have never been discounted. In this case, no part of the $25 discount is allocated to the pump. Instead, it is allocated proportionately to the bicycle and the helmet.

The Variable Consideration Passageway

Variable consideration adds another potential layer of complexity. Just like discounts, variable consideration may be allocated to one or more – but not necessarily all – performance obligations.

For example, a construction contract encompasses several elements and has a tiered performance bonus tied to early completion of one element: 10% bonus for completion by January 1, 8% for completion by January 15, or 5% for completion by January 31. At contract inception, if the contractor deems it probable that he will complete the incentivized element by January 15, then he will allocate all of the 8% bonus to that element rather than to the entire contract.

Another important consideration is that transaction price allocation is determined at contract inception and will not change later as standalone selling prices are updated. Therefore, no reallocation is needed if, for example, the company rolls out its annual pricing update after contract inception but prior to contract completion.

As uncertainties surrounding variable consideration affect transaction prices, however, revenue is recorded using the same steps and criteria as those for contract inception. Using the construction example above, if – after the contract inception –  the contractor determines that he is far enough ahead of schedule to complete the incentivized element by January 1, then he records the additional bonus revenue (2%), allocating 100% of it to that element.

CRI Can Help You Move Along with Transaction Price Allocation

If revenue allocation for your bundled contracts leaves you at a junction in the maze, then let CRI help you move forward. Contact us for assistance with transaction price allocation in your business. For more of our revenue recognition news and resources, visit the Revenue Recognition section of the CRI website.

2018-11-12T15:45:07+00:00March 28th, 2017|REVENUE RECOGNITION|