Previously, we addressed Steps 1, 2, and 3 of the Accounting Standard Update (ASU) No. 2014-19, Revenue from Contracts with customers. This post moves on to Step 4, allocating the transaction price to the performance obligations in the contract. This, and one final, step addresses when and how much revenue should be recognized from business contractual obligations.
Step 4: Allocate Transaction Price to the Performance Obligations Within the Contract
This step relates to any entity providing two or more services or products and invoicing the customer for the combined output, as opposed to each individual service or product. This will cause a dramatic process revision in how transaction price is allocated between multiple performance obligations as compared to the current revenue guidance that entities have to estimate selling prices that stand alone. There are many similarities between the old revenue standards and this one, however there could be slight variations that result in different timing of revenue recognition, and different amounts allocated of revenue.
Current Revenue Language on Allocating Transaction Price
Current revenue language states that entities which offer bundled services or goods use standalone selling prices for each product and service in order to decide how much of the transaction price should be allocated to each deliverable (also known as a performance obligation). This language does not change in the updated revision. Additionally, the existing guidance stated that entities needed to enact a relative selling price hierarchy as they estimated the standalone selling price. Within accounting, a three-level hierarchy was created to consider:
- Vendor-specific objective evidence
- Third-party evidence
- Best estimated selling price
Complexities were many and significant efforts to aggregate data in order to determine selling price.
Changes to Allocating Transaction Price
When entities do not sell certain products or services as standalone and are required to estimate this standalone selling price is where the new revenue guidance changes from existing language. The new guidance allows entities to choose from optional methodology when estimating standalone selling price: adjusted market assessment, expected cost plus a margin, and residual approach (only in certain circumstances). These are the methods that will most likely be used, but do not constitute an exhaustive list by any means.
Trepidations Concerning Allocating Transaction Price
Within the standard itself, two questions are poised, and addressed to assist with determining allocation of transaction price.
- Can there be a set range of standalone selling prices for services or goods underlying a performance obligation? Geographic region and customer class could affectively produce a range or separate standalone pricing strategy.
- Should discounts be allocated to separate performance obligations? Variable consideration and discounts should e allocated to performance obligations along with the allocation for separate performance obligations. An exception would be if there are circumstances and evidence to indicate otherwise.
Affected Contracts That Include Bundled Performance Obligations
Step 4 may affect entities in the technology, manufacturing, and related industries that often bundle, market, and sell goods. Also, the implications within Step 4 could impact how revenue has been recognized previously by an entity and therefore might result in accelerated or possibly delayed recognition with certain performance obligations. The result could be that the efforts for entities processing multiple performance obligations, bundled together, will be significantly more time consuming. With this in mind, it is ideal for entities to prepare for the revenue standard effective date and to communicate in advance potential changes and adjustments to those invested (i.e. board members, members of management, third-party lenders, and shareholders). A reminder, the effective date for most entities is annual reporting periods after December 15, 2018.
Allocating Transaction Price Assistance from Your Knoxville TN Accountant
At Lawhorn CPA Group, we have been diligently preparing for these updates. Any additional questions or concerns that you may have regarding these changes can be addressed by calling 865-212-4867, online, or emailing us.