Many contracts require companies to fulfill multiple performance obligations. Step four in the five-step revenue recognition process requires that entities allocate the transaction price to each performance obligation in proportion to its standalone selling price (SSP). The standalone selling price is the price at which the entity would sell a promised good or service individually to a customer.
ASC 606 Revenue from Contracts with Customers (ASC 606) requires companies to estimate the SSP if the selling price is not readily observable. The remainder of this paper will describe how to estimate standalone selling price and present examples of estimating and allocating the transaction price.
Methods of Assigning Standalone Selling Price
The best evidence of standalone selling price is the price that the entity charges for the good or service in a separate transaction with a customer. However, sometimes goods or services are sold exclusively as a package combined with other goods or services rather than on an individual basis (e.g., nonrenewable customer support). For example, Apple recognizes as a separate performance obligation “the right to receive, on a when-and-if-available basis, future unspecified software upgrades relating to the software bundled with each device.” In these cases, the standalone selling price must be estimated. The revenue standard does not prohibit any method for estimating the standalone selling price as long as the estimation results in an accurate representation of what price would be charged in a separate transaction. However, the standard does include the following three examples of suitable estimation methods:
- Adjusted market assessment approach. This approach considers the market in which the goods or services are sold and estimates the price that a customer of that market would be willing to pay. This method is suitable in situations where a competitor offers similar goods or services that can be used as a basis for the analysis. Activision Blizzard Inc., an American video game company, uses this approach when pricing their new games. This method is described in the company’s 10-K; information pulled from market data, pricing strategies for other products and competitors, and the design of both the online and offline version of games is considered.
- Expected cost plus margin approach. Expected cost plus margin considers the forecasted costs of fulfilling the performance obligation and adds margin at the amount the market would be willing to pay. This method may be most suitable in situations where (1) the demand for the good or service is unknown and information on the demand for similar goods or services from competitors is not available and/or (2) the direct fulfillment costs are clearly identifiable. Lockheed Martin uses this method when allocating revenue to their rockets in bundled service packages. These packages are part of non-U.S. Government contracts that include multiple performance obligations which deliver customized solutions unique to each customer.
- Residual approach. This approach allows an entity that has observable standalone selling prices for one or more of the performance obligations to allocate the remaining transaction price to the goods or services that do not have observable standalone selling prices. The sum of the observable standalone selling prices is deducted from the total transaction price to find the residual estimated standalone selling price for the goods or services that do not have observable standalone selling prices. The residual approach can only be used if (1) the entity sells the same good or service to multiple customers for a wide variety of prices (highly variable) or (2) the entity has not established a price for that good or service and the good or service has not been sold previously on a standalone basis. The residual approach is intentionally limited to ensure that companies first attempt to utilize another acceptable method to reach a reasonable estimation. National Instruments Corporation, an automation testing and equipment company, uses this method to determine the prices of some of their software in enterprise (large company) agreements. The company first applies other approaches to each standalone selling price within its contract, then applies the remaining percentage to the maintenance fees. Finally, the company reevaluates if that approach has produced a realistic SSP for that section of the license (June 2019).
Regardless of the approach used, the standalone selling price must be determined at the outset of the contract and should not be updated to reflect changes between contract inception and performance completion, with the exception of contract modifications (for more information see Contract Modifications). Management should consider all information and maximize observable inputs in determining which approach to use. For example, although an entity may not sell an item on a standalone basis or have a price for that item, it should first consider any available information from competitors to make an estimate before relying on the residual approach.
The actual price charged to customers is rarely represented by a point estimate but may fall within a range of numbers over time. One method of determining standalone selling price for observable prices is to analyze the entire population of standalone sales (or stratified sections of that population) to find a narrow range of prices where a substantial majority of standalone sales occur. Judgment will be involved in deciding which point in the range to use for the practical purpose of allocating consideration. Once a point in the range has been chosen, generally that point should be consistently applied to all similar transactions.
The following example illustrates how to estimate the standalone selling price using each of the three approaches described above.
Example: Determining SSP for Telephone Support
Vendor Y sells two items: Product A and telephone support. Product A is a tangible product used in a production process. Telephone support is available for one year after delivery of all products.
On January 1, Vendor Y enters an arrangement with Customer U to provide Product A on February 1. Telephone support also begins on February 1 and lasts for one year. Total arrangement consideration is $6,000, due on delivery of Product A. Telephone support does not have an established price and is not sold separately to customers. Assume that the customers do not renew the telephone support after year 1 (i.e., there are no standalone sales of support). Vendor Y concludes that it has enough historical sales information for Product A to support a standalone selling price. Most sales of product A to customers in the same region as Customer U were within the range of $5,000 to $5,500. Vendor Y decides to use the lower end of the range to establish standalone selling price. The telephone support has not been sold on a standalone basis and will have to be estimated.
Adjusted Market Assessment Approach:Under the adjusted market assessment approach, Vendor Y searches for competitors that sell similar telephone support services on a standalone basis. Assume that Vendor Y finds two competitors selling these services on a standalone basis between a price range of $1,200 to $1,500. Vendor Y should consider several factors to determine the price it could charge similar customers: market share, expected profit margin, customer/geographic segments, distribution channel, etc. After considering these factors, Vendor Y estimates that it could sell the telephone services for $1,250 to customers with a similar profile to Customer U. The estimated standalone selling price would be $1,250 under this approach.
Expected Cost Plus Margin Approach:Under the cost plus margin approach, Vendor Y determines all the direct and indirect costs associated with providing the telephone support. The costs considered include the personnel employed to provide the support, the costs to provide the telephone lines, the telephones and computer equipment needed to provide the support. After considering all these costs, Vendor Y concludes that the telephone support will cost $900. After determining the cost, Vendor Y should determine an appropriate margin that the market would be willing to pay by considering several factors, including industry sales price averages, market conditions, profit objectives, margin achieved on similar products, etc. After considering these factors, Vendor Y determines an appropriate margin in the industry would be $500. The estimated standalone selling price would be $1,400 under this approach.
Residual Approach:The company should first maximize observable inputs to make an estimate as illustrated in the adjusted market assessment approach and the expected cost plus margin approach. If none of these are appropriate, the residual approach can be used. Under the residual approach, Vendor Y determines the standalone selling price of the telephone support by reducing the transaction price ($6,000) by the amount of the observable standalone selling prices, or in this case, Product A ($5,000). The remaining amount ($1,000) would be considered the standalone selling price of the telephone support under this approach. Using the standalone selling prices developed in the examples above, the following table illustrates how to allocate the transaction price under each method:
|Method||Standalone Selling Price Product A||Standalone Selling Price Telephone Support||Transaction Price Allocated to Product A||Transaction Price Allocated to Telephone Support|
|Adjusted Market Assessment||$5,000||$1,250||(5,000/6,250)*6,000 = $4,800||(1,250/6,250)*6,000 = $1,200|
|Cost Plus||$5,000||$1,400||(5,000/6,400)*6,000 = $4,688||(1,400/6,400)*6,000 = $1,312|
Combination of Methods
A combination of methods may be used to determine the standalone selling price for each performance obligation that does not have an observable standalone selling price. ASC 606-10-32-35 states that in some situations, the residual approach may be used to determine the aggregate standalone selling price of two or more goods or services with highly variable or uncertain standalone selling prices. Once the aggregate residual amount is determined for those goods or services in total, other estimation methods (adjusted market assessment, cost plus, etc.) may be employed to determine the standalone selling price of those goods or services on an individual level.
Activision Blizzard, Inc. (Activision) is an American video game holding company that developed games such as Candy Crush, Call of Duty, and World of Warcraft. In response to an SEC comment letter from January 2020, Activision described its approach to determining the standalone selling prices of both its offline campaign and online functionality performance obligations associated with the Call of Duty: WWII game (January 2020):
As disclosed in our 2018 Form 10-K, determining the SSP for the two performance obligations in a Call of Duty title is inherently subjective and requires significant judgment. We determined that an adjusted market approach was the most appropriate method to determine the SSP for each of the performance obligations.
After evaluating both performance obligations, Activision concluded that the relative value of a license to the game software that is accessible without an internet connection and the online functionality was 20% and 80%, respectively. The company also considered whether the allocation of the transaction price at a 20% and 80% split was consistent with the objective of ASC 606-10-32-28:
We believe the online functionality of our games is critical and represents the most significant factor supporting the value of a Call of Duty title. In addition, we looked at other qualitative factors, such as:
- where our game development personnel focus on creating the greatest level of new features, content, and innovation;
- how we market our games; and
- for how many months users are staying engaged with our online content.
Activision determined that these qualitative factors indicated that the online functionality was the more valuable performance obligation in Call of Duty: WWII game sales which gave the company further comfort that the transaction price allocation was reasonable and consistent with the objective in ASC 606-10-32-35.
SeaChange International Inc (SeaChange) is a global, public supplier of video delivery software that provides video streaming, linear TV, and video advertising technology for operators, content owners, and broadcasters. In a letter dated February 10, 2021, the SEC sent SeaChange the following request:
You indicate in your response that you use the residual approach to determine the selling price of your Framework software license and appear to rely on ASC 606-10- 32-34(c)(1) in that determination. Please more fully explain to us how you evaluated other methods to estimate the standalone selling price of the Framework software license.
In its response, SeaChange evaluated each performance obligation to allocate each portion of the transaction price appropriately and relied on ASC 606-10-32-33 and the three methods for estimating the standalone selling price of its Framework software licenses:
- Adjusted Market Assessment Approach
SeaChange cited its competitors’ prices being highly variable and diverse and, because “there is no retail market to facilitate a comparison of prices…and the Company does not have access to its competitors’ market data…” SeaChange determined this is not the appropriate method of estimating the standalone selling price.
- Expected Cost Plus Margin Approach
SeaChange stated that its Framework software licenses are not custom-built for individual customers and that any costs incurred to develop the product are not used to establish the prices for customers. Therefore, the company determined that this is not an appropriate method of estimating the standalone selling price.
- Residual Approach
SeaChange recognized that under ASC 606-10-32-34(c), selling prices must be highly variable or uncertain in order to use the residual approach. The company asserted that the selling price is highly variable because the Framework product “does not have a set price. Since implementing this new go to market model, we have sold thirty-two (32) deals ranging in price of less than $1,000,000 to over $5,000,000.” Additionally, the company did not believe there was “a discernible concentration around a single price, range of prices, or other metrics” and concluded that the selling price is highly variable.
SeaChange also stated that the selling price is uncertain. Because “the Company does not have a history of standalone sales for software (i.e. without annual maintenance, installation, or other professional services,” the selling price of the software included in the Framework is uncertain.
Based on these factors, SeaChange determined that the residual approach is the most appropriate method to determine the standalone selling price of its Framework software license (March 2021 letter to the SEC).
Talend S.A. is an open source, data solutions company. The company differentiates itself by using a higher quality of service in tandem with its products. Talend was asked by the SEC to explain its reasons for using an expected cost plus margin approach over a more recognizable adjusted market assessment approach (January 2020). Talend responded with the following analysis:
Specifically, under the proprietary software model, once the IP has been delivered, the support provided by the vendor is minimal. This differs from the Company’s high level of support, which requires regular interaction with the customer to ensure maximum utilization of the software. Furthermore, when compared to the allocation percentage adopted by the proprietary data analytics software vendor referenced above, which allocates 40-50% of transaction price to PCS, the Company believes its business model (as an open-source licensor, where much of the Company’s software code is available for use for free, but with a similarly high level of support) would suggest it should allocate substantially less of the transaction price to the license of IP than this comparable software vendor and more to the PCS.
As part of the initial adoption and ongoing review of its stand-alone selling price analysis, the Company noted: in) the absence of directly referenceable benchmarks due to few open-source companies with similar business models upon which to develop a precise market assessment approach and ii) the absence of observable prices as the Company’s products are sold as a bundle, including the license and PCS. Therefore, the Company concluded that it was appropriate to use a cost plus margin approach (see ASC 606-10-32-34(b)) to estimate stand-alone selling prices for each performance obligation.
In July 2019, the SEC asked Electronic Arts Inc. (EA) to provide more information about how it calculates the standalone selling prices of performance obligations related to video games. In its response, EA explains its analysis of the three performance obligations inherent in its game sales: online hosting, software rights, and future updating rights (July 2019).
EA first verified its method for online hosting:
We used a cost plus margin analysis and reviewed available market data to establish the SSP value of the online hosting performance obligation. With respect to the cost plus margin analysis, we used internal financial data to determine the average cost of providing hosting support for each of our Games with a Service. A reasonable margin was then added to this cost based on our internal review of a typical retail mark-up for our Games with a Service.
Software rights were relatively simple for EA because the company was able to use competitors’ price data:
In order to derive the SSP value for the software license performance obligation, we noted that certain third-party companies in our industry sell games that provide neither future update rights nor online hosting performance obligations for the game. We analyzed pricing for a portfolio of third-party games that do not provide future update rights or online hosting performance obligations and noted an average price.
EA had to perform additional analysis to estimate the standalone selling price of the future update rights because no other close competitors sell future update rights as a separate service. The closest example EA could find was in the computer software industry. Companies in this industry often sell maintenance and support (M&S) packages as a separate product, pricing this product as a percentage of the corresponding software’s standalone selling price. These support packages are similar to EA’s update service, and the products have a similar client type. EA used the same estimation method, basing the price on a flat percentage commonly used among computer software companies for the M&S service.
ASC 606 outlines three methods of recognizing the standalone selling price of a product: adjusted market assessment, expected cost plus margin, and residual approach. The method chosen should be constantly reevaluated when there are discounts and packages offered, and a company can use a variety of these methods to identify which is most accurate. By evaluating and possibly combining the methods, companies can identify the best allocation of product prices.
- ASC 606-10-32-31 to 32-35
- EY, Financial Reporting Developments: “Revenue from Contracts with Customers.” January 2020. Section 6.1.
- KPMG, Issues In-Depth: “Revenues from Contracts with Customers.” May 2016. Section 220.127.116.11, 18.104.22.168.
- PWC, “Revenue from contracts with customers.” March 2020. Section 5.2, 5.3.
- Apple’s 2019 Form 10-K Page 25
- Activision Blizzard Inc.’s 2019 Form 10-K Page 56
- Lockheed Martin’s 2019 Form 10-K Page 47