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Transaction Price Allocation: How to Determine the Stand-Alone Selling Price

On May 28, 2014 the final standard standard on revenue from contracts with customers was issued. The standard outlines guidance for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. Continue reading to learn more about Transaction price allocation under the new revenue recognition standard.

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On May 28, 2014 the final standard standard on revenue from contracts with customers was issued. The standard outlines guidance for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. Continue reading to learn more about Transaction price allocation under the new revenue recognition standard.

On May 28, 2014 the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) issued their final standard on revenue from contracts with customers. The standard, issued as ASU 2014-09 by the FASB and as IFRS 15 by the IASB, outlines guidance for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance.

The core principle of the standard is to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The new revenue recognition guidance prescribes five core principles to recognizing revenue. This article aims to take a deeper dive into Step 4 of those principles, specifically the determination of a stand-alone selling price.

While straightforward in instances of a single performance obligation, Step 4 gains complexity when multiple performance obligations are identified. In such instances, a transaction price must be allocated across multiple performance obligations. To allocate the transaction price across multiple performance obligations, a stand-alone selling price must be either identified or estimated via an appropriate method.

Under the new revenue recognition guidance, the stand-alone selling price is the price at which an entity would sell a good or service (performance obligation) separately to a customer. The best evidence of stand-alone selling price per the ASU 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.” The stand-alone selling price should be determined at contract inception and would not be reassessed or updated thereafter unless a change in the contract were to occur. If the individual good or service is not sold separately, the entity must estimate the stand-alone selling price by using a method that maximizes the use of observable inputs. The most common and acceptable estimation methods are as follows, (1) adjusted market assessment, (2) expected cost plus a margin, and (3) a residual approach. The following breakdown of each method comes from ASU Section 606-10-32-34

Adjusted Market Assessment

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 Costs Plus a Margin

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 stand-alone selling price by reference to the total transaction price less the sum of the observable stand-alone 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 stand-alone selling price of a good or service only if one of the following criteria is met:

  1. The entity sells the same good or service to different customers (at or near the same time) for a broad range of amounts (that is, the selling price is highly variable because a representative stand-alone selling price is not discernible from past transactions or other observable evidence).
  2. The entity has not yet established a price for that good or service, and the good or service has not previously been sold on a stand-alone basis (that is, the selling price is uncertain).

Overall the guidance does state that a combination of methods may need to be used to estimate the stand-alone 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 stand-alone selling prices. Additionally entities should choose the method that maximizes the use of observable inputs and accurately 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 effective date for all non-public entities are annual reporting periods beginning after December 15, 2018, and interim reporting periods within annual reporting periods beginning after December 15, 2019.

If you have any specific questions regarding the new guidance for revenue recognition, please contact your blumshapiro partner for assistance or Janet Prisloe, Partner and leader of the blumshapiro Manufacturing, Distribution& Retail Industry Group.

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