• COVID-19
  • Insights
  • Who We Help
    •   Industrial Automation
    •   Manufacturing & Distribution
    •   A&E Professional Services
    •   International Businesses
      • ◦   Expanding Outside the U.S.
      • ◦   Expanding to the U.S.
  • Services
    •   COVID-19
      • ◦   Cash Flow Confidence Assessment
      • ◦   Maximize Your Loan Forgiveness
      • ◦   5 Key Focus Areas
      • ◦   COVID-19 Resource Center
    •   Client Accounting
      • ◦   Software Solutions
      • ◦   Accounting Support
      • ◦   Reporting
    •   Tax
      • ◦   R&D Tax Credit
      • ◦   Tax Credits & Incentives
      • ◦   Tax Structure
      • ◦   Federal Tax
      • ◦   State & Local Tax
      • ◦   Personal Tax
      • ◦   Other Tax Filings
    •   Advisory & Assurance
      • ◦   Assurance Levels
      • ◦   Reporting
      • ◦   Employee Benefit Plan Audits
      • ◦   Technical Accounting & Reporting
    •   Consulting
      • ◦   Data Analytics
      • ◦   Transaction Services
      • ◦   Business Planning
      • ◦   Succession & Exit Strategies
    •   International
      • ◦   International Tax
      • ◦   Foreign Direct Investment
      • ◦   Global Expansion
      • ◦   International Accounting
  • Events
  • Careers
    •   Why C&M
    •   Students
      • ◦   Campus Events
      • ◦   Internships
      • ◦   Reach Beyond Program
    •   Experienced Professionals
      • ◦   Team member profile videos
    •   Opportunities
    •   Employee Journals
    •   Office Tour
  • About Us
    •   How We Help
      • ◦   Service Approach
      • ◦   Affiliations
      • ◦   Communications & Technology
    •   Meet Our Team
    •   Testimonials
    •   Our Videos
    •   Our Story
  • Contact Us
  • Subscribe
CHANGE COUNTRY:
  • United States
  • 中国
  • Client Login
Clayton & McKervey Logo
  • COVID-19
  • Insights
  • Who We Help
  • Services
  • Events
  • Careers
  • About Us
  • Contact Us
  • Subscribe
    • Most Recent Insights
  1. Home
  2. Insights
  3. Revenue Recognition: Allocating Transaction Price

Revenue Recognition: Allocating Transaction Price

Posted by Julie Killian on December 19, 2017

Julie Killian Julie Killian

Over the past several months Clayton & McKervey has provided information about the new revenue recognition standard released by the Financial Accounting Standards Board (FASB); (Revenue from Contracts with Customers: Topic 606). The standard replaces the current revenue guidance found in multiple places in the FASB codification, and provides a single comprehensive standard that will apply to nearly all industries and will significantly change how revenue is recognized.

The standard provides a five-step process for recognizing revenue, as follows:

  1. Identify the contract with the customer
  2. Identify the performance obligations in the contract
  3. Determine the transaction price for the contract
  4. Allocate the transaction price to each specific performance obligation
  5. Recognize the revenue when the entity satisfies each performance obligation

Step 4

After determining the transaction price in Step 3, companies need to allocate that transaction price to the specific performance obligations identified in the contract. The transaction price is allocated to the performance obligations based on its relative standalone selling price.  The standalone selling price for each good or service representing a performance obligation should be determined at the contract inception.

The standalone selling price is defined as the price that an entity would sell the good or service for if they sold it separately to a customer.  The best evidence of that price is if the entity has separate actual sales to customers of a similar good or service. Many times this easily observable selling price is not available, so an entity has to estimate it using observable inputs where possible. Some of these inputs include market conditions, entity-specific factors, and customer information. The methodology to estimate standalone selling price should be applied consistently in like circumstances.

ASC 606 includes specific suitable methods for estimating the standalone selling price of goods and services, including:

a. Adjusted market assessment approach: An entity evaluates the market in which it sells goods or services and estimates the price a customer in that market would be willing to pay for the goods or services. This approach may also include using prices from the entity’s competitors for similar goods or services and adjusting those prices as needed to reflect the entity’s costs and margins.

b. Expected cost plus a margin approach: An entity estimates the expected costs to satisfy a performance obligation and then adds an appropriate margin for that good or service.

c. Residual approach: An entity may estimate the standalone selling price by reference to the total transaction price less the sum of observable standalone selling prices of other goods or services in the contract. This method can only be used if one of the following criteria are met:

  • There is a broad range of current selling prices to other customers and no single representative selling price
  • The good or service has not previously been sold and there is no established price for the good or service

It is possible that an entity may need to use a combination of methods. Some other considerations in allocating transaction price are allocation of a discount and the allocation of variable consideration.

Allocation of a Discount

A customer may receive a discount for purchasing a bundle of goods or services. When this occurs the sum of the standalone selling prices of the promised goods and services may exceed the promised consideration in a contract (i.e. the bundle is sold at a discount). Because the total transaction price is allocated based on relative standalone selling prices this discounted price only causes complexity when the discount should be allocated to one or more specific performance obligations, but not all. A discount should be allocated entirely to certain performance obligations, but not all, if the following criteria are met:

  • The entity regularly sells each distinct good or service on a standalone basis
  • The entity regularly sells on a standalone basis a bundle of some of those distinct goods or services at a discount to their standalone selling prices
  • The discount attributable to each bundle described in (2) is substantially the same as the discount in the contract and the performance obligations to which the entire discount belongs is readily observable

If there is a discount allocated to some but not all performance obligations in the contract, the allocation should be made before using the residual approach to estimate any standalone selling prices.

Allocation of Variable Consideration

Variable consideration in a contract may be related to the entire contract or to a specific part of the contract. The variable amount of the consideration should be allocated entirely to a performance obligation or to a distinct good or service that forms part of single performance obligation if both of the following criteria are met:

  1. The terms of the variable payment relate directly to a performance obligation
  2. Allocating the variable consideration entirely to a single performance obligation meets the overall goal to allocate the transaction price in an amount that the entity expects to receive for that individual good or service. In other words, the variable consideration can be allocated entirely to a performance obligation if it doesn’t result in allocating more or less revenue than should be allocated based on standalone selling prices.

Subsequent changes in selling prices should be allocated to the contract in a way that is consistent with the original allocation of the transaction price, except in some unique circumstances where changes relate to one specific performance obligation or there is a contract modification.

One of the important considerations in step 4 of ASC 606 is the concept of observable evidence.  Good documentation of the manner of determining observable evidence for standalone selling prices, allocating discounts and variability will be important. The requirements in Step 4 will require significant judgment and resources to document the conclusions.

For more information about the impact of the new revenue recognition standards, contact Julie Killian.

Our team is always ready to help.

Please contact us for more information.

Julie Killian

Julie Killian

Shareholder, Advisory & Assurance

Contact Julie   |   Read Julie's bio

related news

How to Claim R&D Tax Credits

Part four of our R&D series answers two common questions about the R&D tax credit: How do I claim the R&D tax credit? Do I really need to claim the…

Read full story

IRS Issues New Guidance on PPP and Employee Retention Credit Eligibility

The IRS issued highly anticipated guidance regarding the employee retention credit (ERC) on March 1. We have previously outlined how the Consolidated Appropriations Act, passed in December, permitted employers receiving…

Read full story

Honoring International Women’s Day

In honor of International Women’s Day, I’d like to take a moment to recognize the talented women who have helped build our outstanding reputation within the business community – both…

Read full story

How to Calculate R&D Tax Credits

As we’ve seen in the first two installments of this series, business owners often miss out on the R&D tax credit opportunity and the bottom-line infusion it can provide. Many…

Read full story

Doing Business in Mexico: What to Expect this Year

Without a doubt, this year will be interesting for Mexico. To start, it’s an election year and we all know what that means…a lot of uncertainty. As the global pandemic…

Read full story

Categories

Jump directly to the topics that matter to you most.

  • A&E Professional Services
  • About Us
  • Advisory & Assurance
  • Business Owners
  • C&M Press Releases
  • Careers
  • China Consulting
  • Clayton & McKervey
  • Client Accounting Services
  • Consulting
  • COVID-19
  • Data Analytics
  • Estate Planning
  • Expanding Outside the U.S.
  • Expanding to the U.S.
  • From the President
  • Industrial Automation
  • International
  • Manufacturing & Distribution
  • Mexico Consulting
  • Podcasts
  • Private Client Services
  • Tax & Tax Credits
  • Transaction Services
  • Videos

Authors

Read news direct from our managers and stakeholders.

    • Ben Smith
    • Beth Butchart
    • Bryan Powrozek
    • Carlos Calderon
    • Casey Haggerty
    • Clayton & McKervey
    • Dave Van Damme
    • Denise Asker
    • Eric Lin
    • Jim Biehl
    • Julie Killian
    • Kevin Johns
    • Margaret Amsden
    • Miroslav Georgiev
    • Nina Wang
    • Rob Dutkiewicz
    • Ruben Ramirez
    • Sarah Russell
    • Sue Tuson
    • Tarah Ablett
    • Teresa Gordon
    • Tim Finerty
    • Tim Hilligoss
    • Wendy Reedy

Additional Resources

Additional news from Clayton & McKervey can be found below.

  • Subscribe to our email newsletter
  • View upcoming events
  • Contact us to let us know how we can help you
  • Main Content
  • Related Insights

Revenue Recognition: Allocating Transaction Price

Posted by Julie Killian on December 19, 2017

Julie Killian

Over the past several months Clayton & McKervey has provided information about the new revenue recognition standard released by the Financial Accounting Standards Board (FASB); (Revenue from Contracts with Customers: Topic 606). The standard replaces the current revenue guidance found in multiple places in the FASB codification, and provides a single comprehensive standard that will apply to nearly all industries and will significantly change how revenue is recognized.

The standard provides a five-step process for recognizing revenue, as follows:

  1. Identify the contract with the customer
  2. Identify the performance obligations in the contract
  3. Determine the transaction price for the contract
  4. Allocate the transaction price to each specific performance obligation
  5. Recognize the revenue when the entity satisfies each performance obligation

Step 4

After determining the transaction price in Step 3, companies need to allocate that transaction price to the specific performance obligations identified in the contract. The transaction price is allocated to the performance obligations based on its relative standalone selling price.  The standalone selling price for each good or service representing a performance obligation should be determined at the contract inception.

The standalone selling price is defined as the price that an entity would sell the good or service for if they sold it separately to a customer.  The best evidence of that price is if the entity has separate actual sales to customers of a similar good or service. Many times this easily observable selling price is not available, so an entity has to estimate it using observable inputs where possible. Some of these inputs include market conditions, entity-specific factors, and customer information. The methodology to estimate standalone selling price should be applied consistently in like circumstances.

ASC 606 includes specific suitable methods for estimating the standalone selling price of goods and services, including:

a. Adjusted market assessment approach: An entity evaluates the market in which it sells goods or services and estimates the price a customer in that market would be willing to pay for the goods or services. This approach may also include using prices from the entity’s competitors for similar goods or services and adjusting those prices as needed to reflect the entity’s costs and margins.

b. Expected cost plus a margin approach: An entity estimates the expected costs to satisfy a performance obligation and then adds an appropriate margin for that good or service.

c. Residual approach: An entity may estimate the standalone selling price by reference to the total transaction price less the sum of observable standalone selling prices of other goods or services in the contract. This method can only be used if one of the following criteria are met:

  • There is a broad range of current selling prices to other customers and no single representative selling price
  • The good or service has not previously been sold and there is no established price for the good or service

It is possible that an entity may need to use a combination of methods. Some other considerations in allocating transaction price are allocation of a discount and the allocation of variable consideration.

Allocation of a Discount

A customer may receive a discount for purchasing a bundle of goods or services. When this occurs the sum of the standalone selling prices of the promised goods and services may exceed the promised consideration in a contract (i.e. the bundle is sold at a discount). Because the total transaction price is allocated based on relative standalone selling prices this discounted price only causes complexity when the discount should be allocated to one or more specific performance obligations, but not all. A discount should be allocated entirely to certain performance obligations, but not all, if the following criteria are met:

  • The entity regularly sells each distinct good or service on a standalone basis
  • The entity regularly sells on a standalone basis a bundle of some of those distinct goods or services at a discount to their standalone selling prices
  • The discount attributable to each bundle described in (2) is substantially the same as the discount in the contract and the performance obligations to which the entire discount belongs is readily observable

If there is a discount allocated to some but not all performance obligations in the contract, the allocation should be made before using the residual approach to estimate any standalone selling prices.

Allocation of Variable Consideration

Variable consideration in a contract may be related to the entire contract or to a specific part of the contract. The variable amount of the consideration should be allocated entirely to a performance obligation or to a distinct good or service that forms part of single performance obligation if both of the following criteria are met:

  1. The terms of the variable payment relate directly to a performance obligation
  2. Allocating the variable consideration entirely to a single performance obligation meets the overall goal to allocate the transaction price in an amount that the entity expects to receive for that individual good or service. In other words, the variable consideration can be allocated entirely to a performance obligation if it doesn’t result in allocating more or less revenue than should be allocated based on standalone selling prices.

Subsequent changes in selling prices should be allocated to the contract in a way that is consistent with the original allocation of the transaction price, except in some unique circumstances where changes relate to one specific performance obligation or there is a contract modification.

One of the important considerations in step 4 of ASC 606 is the concept of observable evidence.  Good documentation of the manner of determining observable evidence for standalone selling prices, allocating discounts and variability will be important. The requirements in Step 4 will require significant judgment and resources to document the conclusions.

For more information about the impact of the new revenue recognition standards, contact Julie Killian.

Our team is always ready to help.

Please contact us for more information.

Julie Killian

Shareholder, Advisory & Assurance

Contact Julie   |   Read Julie's bio

related news

How to Claim R&D Tax Credits

Part four of our R&D series answers two common questions about the R&D tax credit: How do I claim the R&D tax credit? Do I really need to claim the…

Read full story

IRS Issues New Guidance on PPP and Employee Retention Credit Eligibility

The IRS issued highly anticipated guidance regarding the employee retention credit (ERC) on March 1. We have previously outlined how the Consolidated Appropriations Act, passed in December, permitted employers receiving…

Read full story

Honoring International Women’s Day

In honor of International Women’s Day, I’d like to take a moment to recognize the talented women who have helped build our outstanding reputation within the business community – both…

Read full story

How to Calculate R&D Tax Credits

As we’ve seen in the first two installments of this series, business owners often miss out on the R&D tax credit opportunity and the bottom-line infusion it can provide. Many…

Read full story

Doing Business in Mexico: What to Expect this Year

Without a doubt, this year will be interesting for Mexico. To start, it’s an election year and we all know what that means…a lot of uncertainty. As the global pandemic…

Read full story

Categories

Jump directly to the topics that matter to you most.

  • A&E Professional Services
  • About Us
  • Advisory & Assurance
  • Business Owners
  • C&M Press Releases
  • Careers
  • China Consulting
  • Clayton & McKervey
  • Client Accounting Services
  • Consulting
  • COVID-19
  • Data Analytics
  • Estate Planning
  • Expanding Outside the U.S.
  • Expanding to the U.S.
  • From the President
  • Industrial Automation
  • International
  • Manufacturing & Distribution
  • Mexico Consulting
  • Podcasts
  • Private Client Services
  • Tax & Tax Credits
  • Transaction Services
  • Videos

Authors

Read news direct from our managers and stakeholders.

  • Ben Smith
  • Beth Butchart
  • Bryan Powrozek
  • Carlos Calderon
  • Casey Haggerty
  • Clayton & McKervey
  • Dave Van Damme
  • Denise Asker
  • Eric Lin
  • Jim Biehl
  • Julie Killian
  • Kevin Johns
  • Margaret Amsden
  • Miroslav Georgiev
  • Nina Wang
  • Rob Dutkiewicz
  • Ruben Ramirez
  • Sarah Russell
  • Sue Tuson
  • Tarah Ablett
  • Teresa Gordon
  • Tim Finerty
  • Tim Hilligoss
  • Wendy Reedy

Additional Resources

Additional news from Clayton & McKervey can be found below.

  • Subscribe to our email newsletter
  • View upcoming events
  • Contact us to let us know how we can help you

Website

  • COVID-19
  • Insights
  • Who We Help
  • Services
  • Events
  • Careers
  • About Us
  • Contact Us
  • Subscribe

Location

+1 248.208.8860
2000 Town Center
Suite 1800
Southfield, MI
48075 | USA

Connect

  • Events
  • Newsletter
  • Client Login

Social

  • LinkedIn
  • Facebook
  • Twitter
  • Glassdoor
  • YouTube
  • Instagram

Awards

DFP Top Work Places Best & Brightest
Prime Global

Tax | Accounting | Assurance | Consulting | Highly technical and accessible team of CPAs helping growth driven, closely held, middle market companies compete in the global marketplace. Michigan-based accountants and advisors focused on helping business owners in the United States and throughout Europe and China.

Privacy Policy Disclaimer

© 2021 Clayton & McKervey