In step four of the revenue model, entities are required to allocate the transaction price to the performance obligations in the contract. The transaction price is generally allocated according to the relative standalone selling price method and an example of applying this method is available in Standalone Selling Prices. The standard includes two exceptions to the relative standalone selling price method: allocating discounts and allocating variable consideration.
This article explores the process of allocating discounts, but an in-depth discussion of the second exception is available in Allocating Variable Consideration. The remainder of this article will discuss how to allocate discounts to the transaction price, diversity in thought, and significant changes from Accounting Standards Codification (ASC) 605 to ASC 606.
In many transactions, goods or services are bundled together and sold at a lower price than the separate standalone selling prices of the items. These discounts can be a fixed amount that the customer receives for entering into the contract or a variable amount based on the customer meeting specific requirements.
In the March 2015 Transition Resource Group (TRG) meeting, the group established that variable discounts are primarily subject to the guidance on allocating variable consideration. The staff’s view is that ASC 606-10-32-41 establishes a hierarchy for allocating variable consideration such that any form of variable consideration, including variable discounts, is subject to the guidance on allocating variable consideration. If, under the variable consideration guidance, the variable discount does not meet the criteria necessary to be allocated to a specific performance obligation in the contract, then the discount is subject to the guidance on allocating discounts. A comprehensive discussion of the guidance on allocating variable consideration is available in Allocating Variable Consideration.
Generally discounts are allocated to all of the performance obligations in the contract using the relative standalone selling price method, unless there is observable evidence that the discount relates to only one or more, but not all, of the performance obligations. The discount should be allocated to one or more, but not all of the performance obligations if the following criteria are met:
- All goods or services are regularly sold separately or as part of bundles on a stand-alone basis.
- The entity also regularly sells the separately sold good, service, or bundle at a discount.
- The normal discount of the separately sold good, service, or bundle is substantially the same as the overall discount offered in the contract.
Discounts should be allocated to the transaction price before applying the residual approach. The following examples provide an illustration of how to allocate discounts to the transaction price.
An entity enters into a contract to sell customer U a television, home-entertainment center, and stereo system for a price of $1,000. The standalone selling prices of each item are $600, $300, and $200 respectively. The customer receives a $100 discount for purchasing the items as a bundle. The television and home-entertainment system will be delivered in one month while the stereo system will be taken home by the customer today.
The entity regularly sells the television in a bundle with the home-entertainment center at a discount for $800. The stereo system is rarely bundled with either of the other two items at a discount. Under these circumstances, the entity has observable evidence that the discount should be applied entirely to the television and the home-entertainment center. The discounted price ($800) is allocated to the television and home-entertainment center according to their standalone selling prices as follows:
|Item Sold||Standalone Selling Price||Discounted Price Allocation|
|Television||$600||(600/900)*800 = $533|
|Home-Entertainment Center||$300||(300/900)*800 = $267|
The total transaction price would be allocated as follows:
|Total Transaction Price||$1,000|
If the stereo system was regularly sold in a bundle with either the television or the home-entertainment center, the discount should be allocated to all three products because there is not observable evidence that the discount is entirely attributable to one of the products or bundles.
Diversity in Thought
While accounting for discounts appears to be a straightforward process, a few issues could potentially lead to diversity in practice.
In transactions that involve a large number of goods or services, there can be multiple combinations of those goods or services that are regularly sold as bundles at a discount. Conflicting viewpoints have been addressed as to whether the discount can be applied to specific performance obligations in these situations.
When multiple combinations of goods or services are possible in a contract, the discount should be allocated to all of the performance obligations. When multiple bundles are regularly sold at a discount, the discount in the transaction could stem from more than one of these bundles and therefore should be allocated evenly across all performance obligations.
When multiple combinations of goods or services are possible in a contract, the discount should be allocated to one or more, but not all of the performance obligations if any of the bundles regularly provide a similar discount. The discount offered in the transaction should only be allocated to the bundle that is regularly sold at a similar discount.
It seems that the guidance is written to ensure that the discount is applied to the products that are regularly sold as bundles at a similar discount. With this purpose in mind, an analysis should be performed extensively enough to determine if the discount offered in the transaction is representative of any discounts that the company regularly offers to its customers in a bundle, including a combination of discounts that are offered in separate bundles. If it is, the discount should be allocated to those specific performance obligations; otherwise it should be allocated to all of the performance obligations.
The standard requires that a bundle of goods or services be “regularly sold” on a stand-alone basis. The term “regularly sold” is ambiguous and will require management to exercise judgment to determine what meets that definition. Companies will need to establish an internal policy with clear guidelines on how they determine what constitutes a good or service being “regularly sold” on a stand-alone basis. This policy will need to be applied consistently for each bundle. Additional clarification of what constitutes “regularly sold” will become available as the Securities and Exchange Commission (SEC) comments on the procedures of other companies.
Comparison to ASC 605
Under ASC 605, discounts could not be attributed to one or more, but not all of the deliverables except for in the software industry when the residual method was used. The overall discount was allocated to all of the deliverables in a contract. These restrictions forced companies to recognize less revenue for deliverables that were not related to the discount. Under ASC 606, discounts can be attributed to both delivered items and undelivered items regardless of the industry and to one or more, but not all of the performance obligations. Applying the discount directly to specific performance obligations may more accurately represent the economics of the revenue transactions. These changes will cause the amount of revenue recognized under ASC 605 to differ from ASC 606, but the timing of the recognition will depend on the facts of the situation.
To illustrate, consider the previous example of the television, home-entertainment center, and the stereo system. Under ASC 605, the discount would be evenly applied to all of the items according to the standalone selling prices of the goods, as shown in the following table:
|Item Sold||Standalone Selling Price||Discount Allocated to Goods|
|Television||$600||(600/1,100)*100 = $55`|
|Home-Entertainment Center||$300||(300/1,100)*100 = $27|
|Stereo System||$200||(200/1,100)*100 = $18|
On the day of the transaction, the company would recognize $182 of revenue. This consists of the $200 stereo system minus the $18 of the discount allocated to the stereo system using the standalone selling price method. The remaining amount of the discount would be recognized a month later upon delivery of the television and the home-entertainment center.
Under ASC 606, the discount is attributed to the undelivered items (the television and the home-entertainment center) allowing the company to recognize the full $200 of revenue from the stereo system on the day of the transaction. The discount would be recognized a month later when the television and home-entertainment center are delivered. Similar transactions will allow earlier recognition of revenue under ASC 606.
The flip side of the difference from ASC 605 to ASC 606 is illustrated if we alter the fact pattern. Assume the television and the entertainment center were taken home by the customer on the day of the transaction and the stereo system was delivered at a later date. Under ASC 605, the company would recognize $818 of revenue on the day of the transaction and defer the remaining $182 of revenue until the stereo system was delivered. Under ASC 606, the company would recognize $800 of revenue on the day of the transaction and defer the remaining $200 of revenue until the stereo system was delivered. Similar transactions will cause the company to defer more revenue under ASC 606.
As illustrated in the examples above, the amount of revenue associated with each performance obligation will differ from ASC 605 to ASC 606, but whether more revenue is recognized earlier or deferred depends on the facts of the situation.
Discounts are generally allocated to all performance obligations according to relative standalone selling prices. The revenue standard also provides three criteria to determine if the discount may be allocated to one or more, but not all of the performance obligations. If the three criteria are met, the discount may be allocated to specific performance obligations rather than to all of the performance obligations. The discount can be attributed to both delivered and undelivered goods and services, which is a significant change from ASC 605. Consequently, in these circumstances the amount of revenue associated with each performance obligation will differ from ASC 605 to ASC 606.
- ASC 606-10-32-36 to 32-38
- EY, Financial Reporting Developments: “Revenue from contracts with customers.” August 2017. Section 6.4.
- FASB TRG Memo 31: “Variable Discounts.” 30 March 2015.
- KPMG, Issues In-Depth: “Revenues from Contracts with Customers.” May 2016. Section 188.8.131.52.
- PWC, “Revenue from contracts with customers.” August 2016. Section 5.4.