Article

The ASC 606 transition: Allocating the transaction price to separate performance obligations

Aug. 1, 2016

So far in this series, we have addressed three of the five elements of revenue recognition. The first was to determine whether we had a contract in scope for revenue recognition; next we identified the promises we made to the customer for delivery of goods or services; and then we determined the transaction price, including variable consideration. In this article, we discuss how to allocate the transaction price to the performance obligations in the contract.

The objective of ASC 606 in allocating the transaction price is that the entity will recognize revenue for each performance obligation in the amount the entity expects to receive in exchange for the promised goods or services. To do so, the entity should allocate the transaction price to the promises based on the relative standalone selling price of the separate goods or services. This is defined in the Glossary as follows:

Standalone selling price

The price at which an entity would sell a promised good or service separately to a customer.

Basic allocation

An entity will determine the standalone selling price for each of the performance obligations at the inception of the contract and will not adjust the initial allocation for future changes in any selling prices. The entity should maximize the use of observable inputs when estimating the selling price. The standard describes three suitable methods for determining the standalone selling price, but does not require their use if a more suitable method is available with more observable inputs.

The suggested methods are:

• Adjusted market assessment approach—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.