Revenue Recognition Issue 6 – Allocate Transaction Price to Performance Obligations

Now that the transaction price has been identified under the contract, an analysis should be performed to allocate the transaction price amongst the performance obligations under the contract. These allocations will not always be obvious and will require significant judgment by management. It is assumed these allocations would be based on the relative stand-alone selling prices of the different performance obligations under the contract (except for certain variable consideration and discounts, which can and should be separately assessed). In many cases, however, your sales department may tell you that there is no relative stand-alone selling price for some performance obligations because they never sell certain things on a stand-alone basis. In those cases, management will need to use judgment to estimate the non-observable stand-alone selling price by deciding the relative value of that performance obligation to the overall sale.

Example

If you manufacture and sell a widget for $10, but provide a 6-month unlimited warranty for any product defects, you would need to estimate what a customer would be willing to pay for that product if there were no warranty on the product, and then use that information to assess the relative value of the warranty.

Stay tuned for additional alerts in our Revenue Recognition Readiness Check Series. Next in our series, we will explore Recognizing Revenue When (or as) Performance Obligations are Satisfied.

Please contact your BMF Advisor for additional information regarding the new standards.