International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
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7.1.4.D
Evaluating a contract where the total transaction price exceeds the sum
of the stand-alone selling prices
If the total transaction price exceeds the sum of the stand-alone selling prices it may
indicate that the customer is paying a premium for bundling the goods or services in the
contract. This situation is likely to be rare because most customers expect to receive a
discount for purchasing a bundle of goods or services. If a premium exists after
determining the stand-alone selling prices of each good or service, the entity needs to
evaluate whether it properly identified both the estimated stand-alone selling prices
(i.e. are they too low?) and the number of performance obligations in the contract.
However, if the entity determines that a premium does, in fact, exist after this
evaluation, we believe the entity would need to allocate the premium in a manner
consistent with the standard’s allocation objective, which would typically be on a
relative stand-alone selling price basis.
7.1.5
Measurement of options that are separate performance obligations
An entity that determines that an option is a separate performance obligation (because
the option provides the customer with a material right, as discussed further at 5.6 above)
needs to determine the stand-alone selling price of the option. [IFRS 15.B42].
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If the option’s stand-alone selling price is not directly observable, the entity estimates
it. The estimate takes into consideration the discount the customer would receive in a
stand-alone transaction and the likelihood that the customer would exercise the option.
[IFRS 15.B42]. Generally, option pricing models consider both the intrinsic value of the
option (i.e. the value of the option if it were exercised today) and its time value (e.g. the
option may be more or less valuable based on the amount of time until its expiration
date and/or the volatility of the price of the underlying good or service). An entity is
only required to measure the intrinsic value of the option under paragraph B42 of
IFRS 15 when estimating the stand-alone selling price of the option. In the Basis for
Conclusions, the Board noted that the benefits of valuing the time value component of
an option would not justify the cost of doing so. [IFRS 15.BC390]. Example 28.27 at 5.6
above illustrates the measurement of an option determined to be a material right under
paragraph B42 of IFRS 15.
Paragraph B43 of IFRS 15 provides an alternative to estimating the stand-alone selling
price of an option. This practical alternative applies when the goods or services are
both: (1) similar to the original goods or services in the contract (i.e. the entity continues
to provide what it was already providing); [IFRS 15.BC394] and (2) provided in accordance
with the terms of the original contract. The standard indicates that this alternative
generally applies to options for contract renewals (i.e. the renewal option approach).
[IFRS 15.B43].
The Board stated in the Basis for Conclusions that customer loyalty points and discount
vouchers typically do not meet the above criteria for use of the practical alternative. This is
because customer loyalty points and discount vouchers are redeemable for goods or
services that may differ in nature from those offered in the original contract and the terms
of the original contract do not restrict the pricing of the additional goods or services. For
example, if an airline offers flights to customers in exchange for points from its frequent flyer
programme, the airline is not restricted because it can subsequently determine the number
of points that are required to be redeemed for any particular flight. [IFRS 15.BC 394, BC395].
Under this alternative, a portion of the transaction price is allocated to the option (i.e. the
material right that is a performance obligation) by reference to the total goods or services
expected to be provided to the customer (including expected renewals) and the
corresponding expected consideration. That is, the total amount of consideration
expected to be received from the customer (including consideration from expected
renewals) is allocated to the total goods or services expected to be provided to the
customer, including those from the expected contract renewals. The amount allocated to
the goods or services that the entity is required to transfer to the customer under the
contract (i.e. excluding the optional goods or services that will be transferred if the
customer exercises the renewal option(s)) is then subtracted from the total amount of
consideration received (or that will be received) for transferring those goods or services.
The difference is the amount that is allocated to the option at contract inception. An entity
using this alternative would need to apply the constraint on variable consideration (as
discussed at 6.2.3 above) to the estimated consideration for the optional goods or services
prior to performing the allocation (see Example 28.52, Scenario B, below). [IFRS 15.B43].
It is important to note that the calculation of total expected consideration (i.e. the
hypothetical transaction price), including consideration related to expected renewals, is
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only performed for the purpose of allocating a portion of the hypothetical transaction
price to the option at contract inception. It does not change the enforceable rights or
obligations in the contract, nor does it affect the actual transaction price for the goods
or services that the entity is presently obligated to transfer to the customer (which would
not include expected renewals). Accordingly, the entity would not include any
remaining hypothetical transaction price in its disclosure of remaining performance
obligations (see 11.4.1 below). In this respect, the renewal option approach is consistent
with the conclusion in 5.6.1.D above that, even if an entity may think that it is almost
certain that a customer will exercise an option to buy additional goods or services, an
entity does not include the additional goods or services underlying the option as
promised goods or services (or performance obligations), unless there are substantive
contractual penalties.
Subsequent to contract inception, if the actual number of contract renewals is different
from an entity’s initial expectations, the entity would update the hypothetical
transaction price and allocation accordingly. However, as discussed at 7.1 above, the
estimate of the stand-alone selling prices at contract inception would not be updated.
See Example 28.52, Scenario B below for an example of how an entity could update its
practical alternative calculation based on a change in expectations.
The following example illustrates the two possible approaches for measuring options
included in a contract.
Example 28.52: Measuring an option
A machinery maintenance contract provider offers a promotion to new customers who pay full price for the
first year of maintenance coverage that would grant them an option to renew their services for up to two years
at a discount. The entity regularly sells maintenance coverage for $750 per year. With the promotion, the
customer would be able to renew the one-year maintenance at the end of each year for $
600. The entity
concludes that the ability to renew is a material right because the customer would receive a discount that
exceeds any discount available to other customers. The entity also determines that no directly observable
stand-alone selling price exists for the option to renew at a discount.
Scenario A – Estimate the stand-alone selling price of the option directly (paragraph B42 of IFRS 15)
Since the entity has no directly observable evidence of the stand-alone selling price for the renewal option, it
estimates the stand-alone selling price of an option for a $150 discount on the renewal of service in years two
and three. When developing its estimate, the entity would consider factors such as the likelihood that the
option will be exercised and the price of comparable discounted offers. For example, the entity may consider
the selling price of an offer for a discounted price of similar services found on a ‘deal of the day’ website.
The option will then be included in the relative stand-alone selling price allocation. In this example, there will
be two performance obligations: one-year of maintenance services; and an option for discounted renewals.
The consideration of $750 is allocated between these two performance obligations based on their relative
stand-alone selling prices.
Example 28.27 at 5.6 above illustrates the estimation of the stand-alone selling price of an option determined
to be a material right under paragraph B42 of IFRS 15.
Scenario B – Practical alternative to estimating the stand-alone selling price of the option using the renewal
option approach (paragraph B43 of IFRS 15)
If the entity chooses to use the renewal option approach, it would allocate the transaction price to the option
for maintenance services by reference to the maintenance services expected to be provided (including
expected renewals) and the corresponding expected consideration. Since there is a discount offered on
renewal of the maintenance service, this calculation will result in less revenue being allocated to the first year
of the maintenance service when compared to the amount of consideration received for the first year of service
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(i.e. an amount less than $750). The difference between the consideration received (or that will be received)
for the first year of maintenance service and the revenue allocated to the first year of maintenance service
(i.e. $750) will represent the amount allocated to the option using the renewal option approach.
Assume the entity obtained 100 new customers under the promotion. Based on its experience, the entity
anticipates approximately 50% attrition annually, after giving consideration to the anticipated effect that the
$150 discount will have on attrition. The entity considers the constraint on variable consideration and
concludes that it is not highly probable that a significant revenue reversal will not occur. Therefore, the entity
concludes that, for this portfolio of contracts, it will ultimately sell 175 contracts, each contract providing
one-year of maintenance services (100 customers in the first year, 50 customers in the second year and
25 customers in the third year).
The total consideration the entity expects to receive is $120,000 [(100 × $750) + (50 × $600) + (25 × $600)]
(i.e. the hypothetical transaction price). Assuming the stand-alone selling price for each maintenance contract
period is the same, the entity allocates $685.71 ($120,000/175) to each maintenance contract sold.
During the first year, the entity will recognise revenue of $68,571 (100 one-year maintenance service
contracts sold × the allocated price of $685.71 per maintenance service contract). Consequently, at contract
inception, the entity would allocate $6,429 to the option to renew ($75,000 cash received – $68,571 revenue
to be recognised in the first year).
If the actual renewals in years two and three differ from expectations, the entity would have to update the
hypothetical transaction price and allocation accordingly. However, beyond stating, as discussed at 7.1 above,
that the estimate of the stand-alone selling prices at contract inception would not be updated, the standard is not
explicit about how the entity would update the hypothetical transaction price and allocation. Below is an
illustration of how an entity could update its practical alternative calculation based on a change in expectations.
For example, assume that the entity experiences less attrition than expected (e.g. 40% attrition annually, instead
of 50%). Therefore, the entity estimates that it will ultimately sell 196 one-year maintenance services (100 +
60 renewals after year one + 36 renewals after year two). Accordingly, the total consideration that the entity
expects to receive is $132,600 [(100 × $750) + (60 × $600) + (36 × $600)] (i.e. the updated hypothetical transaction
price). The entity would not update its estimates of the stand-alone selling prices (which were assumed to be the
same for each maintenance period). As such, the entity allocates $676.53 ($132,600/196) to each maintenance
period. The entity would reduce the amount of revenue it recognises in year one by $918 ($68,571 – (100 ×
$676.53)) because the amount allocated to the option would have been higher at contract inception.
The requirement to identify and allocate contract consideration to an option (that has
been determined to be a performance obligation) on a relative stand-alone selling price
basis is likely to be a significant change in practice for many IFRS preparers.
For entities that developed their accounting policy for allocation of revenue in an
arrangement involving multiple goods or services by reference to legacy US GAAP, the
requirements in IFRS 15 are generally consistent with the previous requirements in
ASC 605-25. However, ASC 605-25 required the entity to estimate the selling price of the
option (unless other objective evidence of the selling price existed) and did not provide
an alternative method (i.e. no renewal option approach) for measuring the option.
7.1.5.A
Could the form of an option (e.g. a gift card versus a coupon) affect how
an option’s stand-alone selling price is estimated?
We believe that the form of an option should not affect how the stand-alone selling price
is estimated. Consider, for example, a retailer that gives customers who spend more than
€100 during a specified period a €15 discount on a future purchase in the form of a coupon
or a gift card that expires two weeks from the sale date. If the retailer determines that this
type of offer represents a material right (see 5.6 above), it will need to allocate a portion
of the transaction price to the option on a relative stand-alone selling price basis.
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As discussed at 7.1 above, the standard requires that an entity first look to any
directly observable stand-alone selling price. This requires the retailer to consider
the nature of the underlying transaction. In this example, while a customer can
purchase a €15 gift card for its face value, that transaction is not the same in
substance as a transaction in which the customer is given a €15 gift card or coupon
in connection with purchasing another good or service. As such, the retailer could
conclude that there is no directly observable stand-alone selling price for a ‘free’ gift
card or coupon obtained in connection with the purchase of another good or
> service. It would then need to estimate the stand-alone selling price in accordance
with paragraph B42 of IFRS 15.
The estimated stand-alone selling price of an option given in the form of a gift card or a
coupon would be the same because both estimates would reflect the likelihood that the
option will be exercised (i.e. breakage, as discussed at 8.10 below).
7.1.5.B
Use of the practical alternative when not all of the goods or services in
the original contract are subject to a renewal option
In certain instances, it might be appropriate to apply the practical alternative even if not
all of the goods or services in the original contract are subject to renewal, provided that
the renewal is of a good or service that is similar to that included in the original contract
and follows the renewal terms included in the original contract. Consider a contract to
sell hardware and a service-type warranty where the customer has the option to renew
the warranty only. Furthermore, assume that the renewal option is determined to be a
material right. If the terms of any future warranty renewals are consistent with the terms
provided in the original contract, we believe it is reasonable that the use of the practical
alternative is allowed when allocating the transaction price of the contract.
7.2
Applying the relative stand-alone selling price method
Once an entity has determined the stand-alone selling price for the separate goods or
services in a contract, the entity allocates the transaction price to those performance
obligations. [IFRS 15.76]. The standard requires an entity to use the relative stand-alone selling
price method to allocate the transaction price, except in the two specific circumstances
(variable consideration and discounts), which are described at 7.3 and 7.4 below.
Under the relative stand-alone selling price method, the transaction price is allocated to
each performance obligation based on the proportion of the stand-alone selling price of
each performance obligation to the sum of the stand-alone selling prices of all of the
performance obligations in the contract, as described in Example 28.53 below.
[IFRS 15.76].
We have provided the following example of a relative stand-alone selling price allocation: