Example 28.53: Relative stand-alone selling price allocation
Manufacturing Co. entered into a contract with a customer to sell a machine for £100,000. The total contract price
included installation of the machine and a two-year extended warranty. Assume that Manufacturing Co.
determined there were three performance obligations and the stand-alone selling prices of those performance
obligations were as follows: machine – £75,000, installation services – £14,000 and extended warranty – £20,000.
The aggregate of the stand-alone selling prices (£109,000) exceeds the total transaction price of £100,000,
indicating there is a discount inherent in the contract. That discount must be allocated to each of the
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individual performance obligations based on the relative stand-alone selling price of each performance
obligation. Therefore, the amount of the £100,000 transaction price is allocated to each performance
obligation as follows:
Machine – £68,807 (£100,000 × (£75,000 / £109,000))
Installation – £12,844 (£100,000 × (£14,000 / £109,000))
Warranty – £18,349 (£100,000 × (£20,000 / £109,000))
The entity would recognise as revenue the amount allocated to each performance obligation when (or as) each
performance obligation is satisfied.
The method of allocation in IFRS 15 is not significantly different from the mechanics of
applying the methods that were mentioned in IFRIC 13 to allocate consideration, such
as a relative fair value approach. However, the methodology may be complicated when
an entity applies one or both of the exceptions provided in IFRS 15 (described at 7.3 and
7.4 below). In addition, the standard is likely to require a change in practice for entities
that did not apply a relative allocation approach under legacy IFRS (e.g. entities that
previously applied the residual approach).
7.2.1
Allocating the transaction price in a contract with multiple
performance obligations in which the entity acts as both a principal
and an agent
The standard does not illustrate the allocation of the transaction price for a contract
with multiple performance obligations in which the entity acts as both a principal and
an agent (see 5.4 above for further discussion of principal versus agent considerations).
We illustrate two acceptable ways to perform the allocation for this type of contract
that are consistent with the standard’s objective for allocating the transaction price.
Entities need to evaluate the facts and circumstances of their contracts to make sure
that the allocation involving multiple performance obligations in which an entity acts as
both a principal and an agent meets the allocation objectives in IFRS 15.
Example 28.54: Allocation when an entity is both a principal and an agent in a
contract
Entity X sells two distinct products (i.e. Product A and Product B) to Customer Y, along with a distinct
service for an aggregate contract price of $800. Entity X is the principal for the sale of Product A and
Product B, but is an agent for the sale of the service.
The stand-alone selling price of each good and service in the contract is as follows:
Stand-alone
Contract
selling price
$
Product A
500
Product B
300
Service 200
Total 1,000
Entity X earns a 20% commission from the third-party service provider based on the stand-alone selling price
of the service. That is, Entity X earns $40 of commission (i.e. $200 × 20%) and remits the remaining $160 to
the third-party service provider.
Method A – Entity X determines that it has provided a single discount of $200 (i.e. sum of stand-alone selling
prices of $1,000 less the contract price of $800) on the bundle of goods and services sold to Customer Y in
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the contract (i.e. Products A and B and the service provided by the third-party). In order to allocate the
discount to all of the goods and services in the contract, Entity X considers the performance obligation for
the agency service as part of the contract with Customer Y for purposes of allocating the transaction price.
Entity X determines the stand-alone selling prices of Products A and B and the agency service and allocates
the transaction price of $640 (i.e. $800 contract price less $160 to be remitted to the third-party service
provider) for Products A and B and the service on a relative stand-alone selling price basis. This method is
illustrated, as follows:
Allocated
Stand-alone
transaction
Contract
selling price
price
$
$
Product A
500
(500 ÷ 840 × 640)
381
Product B
300
(300 ÷ 840 × 640)
229
Service
40
(40 ÷ 840 × 640)
30
Total 840
640
Method B – Entity X determines that it has provided a discount of $200 on Products A and B since it is the
principal for the transfer of those goods to Customer Y. Entity X believes the third-party service provider is
a separate customer for its agency services and the commission Entity X expects to be entitled to receive for
the agency service is not part of the transaction price in the contract with Customer Y. Entity X allocates a
transaction price of $600 (i.e. $800 contract price less $200 stand-alone selling price of service) to Product A
and B on a relative stand-alone selling price basis. This method is illustrated, as follows:
Allocated
Stand-alone
transaction
Contract
selling price
price
$
$
Product A
500
(500 ÷ 840 × 600)
375
Product B
300
(300 ÷ 840 × 600)
225
Total 800
600
The entity would recognise $40 separately for its earned commission on the service contract when the
performance obligation for the agency service has been satisfied.
In either method, the same amount of revenue is ultimately recognised (i.e. $640). However, the timing of
revenue recognition would be different if the products and agency service are transferred to the customer at
different times.
7.3 Allocating
variable
consideration
The relative stand-alone selling price method is the default method for allocating the
transaction price. However, the Board noted in the Basis for Conclusions on IFRS 15
that this method may not always result in a faithful depiction of the amount of
consideration to which an entity expects to be entitled from the customer. [IFRS 15.BC280].
Therefore, the standard provides two exceptions to the relative selling price method of
allocating the transaction price.
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The first relates to the allocation of variable consideration (see 7.4 below for the second
exception on the allocation of a discount). This exception requires variable
consideration to be allocated entirely to a specific part of a contract
such as one or more
(but not all) performance obligations in the contract, (e.g. a bonus may be contingent on
an entity transferring a promised good or service within a specified period of time) or
one or more (but not all) distinct goods or services promised in a series of distinct goods
or services that form part of a single performance obligation (see 5.2.2 above). For
example, the consideration promised for the second year of a two-year cleaning
contract will increase on the basis of movements in a specified index. This exception
will be applied to a single performance obligation, a combination of performance
obligations or distinct goods or services that make up part of a performance obligation
depending on the facts and circumstances of each contract. [IFRS 15.84].
Two criteria must be met to apply this exception, as follows:
(a) the terms of a variable payment relate specifically to the entity’s efforts to satisfy
the performance obligation or transfer the distinct good or service (or to a specific
outcome from satisfying the performance obligation or transferring the distinct
good or service); and
(b) allocating the variable amount of consideration entirely to the performance
obligation or the distinct good or service is consistent with the allocation objective
(see 7 above) when considering all of the performance obligations and payment
terms in the contract. [IFRS 15.85].
The general allocation requirements (see 7.1 above) must then be applied to allocate the
remaining amount of the transaction price that does not meet the above criteria.
[IFRS 15.86].
While the language in above criteria (from paragraph 85 of IFRS 15) implies that this
exception is limited to allocating variable consideration to a single performance
obligation or a single distinct good or service within a series, paragraph 84 of IFRS 15
indicates that the variable consideration can be allocated to ‘one or more, but not all’
performance obligations or distinct goods or services within a series. We understand
it was not the Board’s intent to limit this exception to a single performance obligation
or a single distinct good or service within a series, even though the standard uses a
singular construction for the remainder of the discussion and does not repeat ‘one or
more, but not all’.
The Board noted in the Basis for Conclusions that this exception is necessary because
allocating contingent amounts to all performance obligations in a contract may not
reflect the economics of a transaction in all cases. [IFRS 15.BC278]. Allocating variable
consideration entirely to a distinct good or service may be appropriate when the result
is that the amount allocated to that particular good or service is reasonable relative to
all other performance obligations and payment terms in the contract. Subsequent
changes in variable consideration must be allocated in a consistent manner.
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Entities may need to exercise significant judgement to determine whether they meet
the requirements to allocate variable consideration to specific performance
obligations or distinct goods or services within a series. Firstly, entities need to
determine whether they meet the first criterion in paragraph 85 of IFRS 15, which
requires the terms of a variable payment to specifically relate to an entity’s efforts
to satisfy a performance obligation or transfer a distinct good or service that is part
of a series. In performing this assessment, an entity needs to consider the nature of
its promise and how the performance obligation has been defined. In addition, the
entity needs to clearly understand the variable payment terms and how those
payment terms align with the entity’s promise. This includes evaluating any
clawbacks or potential adjustments to the variable payment. For example, an entity
may conclude that the nature of its promise in a contract is to provide hotel
management services (including management of the hotel employees, accounting
services, training and procurement, etc.) that comprise a series of distinct services
(i.e. daily hotel management). For providing this service, the entity receives a
variable fee (based on a percentage of occupancy rates). It is likely that the entity
would determine that it meets the first criterion to allocate the daily variable fee to
the distinct service performed that day because the uncertainty related to the
consideration is resolved on a daily basis as the entity satisfies its obligation to
perform daily hotel management services. This is because the variable payments
specifically relate to transferring the distinct service that is part of a series of distinct
goods or services (i.e. the daily management service). The fact that the payments do
not directly correlate with each of the underlying activities performed each day does
not affect this assessment. See 5 above for further discussion on identifying the
nature of the goods or services promised in a contract, including whether they meet
the series requirement.
In contrast, consider an entity that has a contract to sell equipment and maintenance
services for that equipment. The maintenance services have been determined to be a
series of distinct services because the customer benefits from the entity standing ready
to perform in case the equipment breaks down. The consideration for the maintenance
services is based on usage of the equipment and is, therefore, variable. In this example,
the payment terms do not align with the nature of the entity’s promise. This is because
the payment terms are usage-based, but the nature of the entity’s promise is to stand
ready each day to perform any maintenance that may be needed, regardless of how
much the customer uses the equipment. Since the entity does not meet the criteria to
apply the allocation exception, it must estimate the variable consideration over the life
of the contract, including consideration of the constraint. The entity would then
recognise revenue based on its selected measure of progress (see 8.2 below).
Secondly, entities need to determine whether they meet the second criterion in
paragraph 85 of IFRS 15; to confirm that allocating the consideration in this manner is
consistent with the overall allocation objective of the standard in paragraph 73 of
IFRS 15. That is, an entity should allocate to each performance obligation (or distinct
good or service in a series) the portion of the transaction price that reflects the amount
of consideration the entity expects to be entitled in exchange for transferring those
goods or services to the customer.
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The TRG discussed four types of contracts with different variable payment terms that
may be accounted for as a series of distinct goods or services (see 5.2.2 above) and for
which an entity may reasonably conclude that the allocation objective has been met
(and the variable consideration could be allocated to each distinct period of service,
such as day, month or year) which are detailed below:95
• Declining prices – The TRG agenda paper included an IT outsourcing contract in
which the events that trigger the variable consideration are the same throughout
the contract, but the per unit price declines over the
life of the contract. The
allocation objective could be met if the pricing is based on market terms (e.g. if the
contract contains a benchmarking clause) or the changes in price are substantive
and linked to changes in an entity’s cost to fulfil the obligation or value provided
to the customer;
• Consistent fixed prices – The TRG agenda paper included a transaction processing
contract with an unknown quantity of transactions, but a fixed contractual rate per
transaction. The allocation objective could be met if the fees are priced
consistently throughout the contract and the rates charged are consistent with the
entity’s standard pricing practices with similar customers;
• Consistent variable fees, cost reimbursements and incentive fees – The TRG
agenda paper included a hotel management contract in which monthly
consideration is based on a percentage of monthly rental revenue,
reimbursement of labour costs and an annual incentive payment. The allocation
objective could be met for each payment stream as follows. The base monthly
fees could meet the allocation objective if the consistent measure throughout the
contract period (e.g. 1% of monthly rental revenue) reflects the value to the
customer. The cost reimbursements could meet the allocation objective if they
are commensurate with an entity’s efforts to fulfil the promise each day. The
annual incentive fee could also meet the allocation objective if it reflects the
value delivered to the customer for the annual period and is reasonable
compared with incentive fees that could be earned in other periods; and
• Sales-based and usage-based royalty – The TRG agenda paper included a
franchise agreement in which franchisor will receive a sales-based royalty of 5% in
addition to a fixed fee. The allocation objective could be met if the consistent
formula throughout the licence term reasonably reflects the value to the customer
of its access to the franchisor’s intellectual property (e.g. reflected by the sales that
have been generated by the customer).
It is important to note that allocating variable consideration to one or more, but not all,
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