Once the performance obligations have been identified and the transaction price has been determined, the entity is required to allocate the transaction price to the performance obligations, generally in proportion to their stand-alone selling prices (i.e., on a relative stand-alone selling price basis), with two exceptions.
- Firstly, IFRS 15 requires an entity to allocate variable consideration to one or more, but not all, performance obligations in some situations.
- Secondly, IFRS 15 contemplates the allocation of any discount in an arrangement to one or more, but not all, performance obligations, if specific criteria are met. The transaction price is not reallocated to reflect changes in stand-alone selling prices after contract inception.
The stand-alone selling price is the price at which an entity would sell a good or service on a stand-alone basis at contract inception. When determining stand-alone selling prices, the entity is required to use observable information, if available. If stand-alone selling prices are not directly observable, the entity will need to make estimates based on information that is reasonably available.
Possible estimation approaches include:
- an adjusted market assessment approach; Transaction price allocation
- an expected cost plus a margin approach; or Transaction price allocation
- a residual approach. Transaction price allocation
The use of one, or a combination, of the methods may be appropriate in estimating the stand-alone value of a good or service. Furthermore, these are not the only estimation methods permitted. IFRS 15 allows any reasonable estimation method, as long as it is consistent with the notion of a stand-alone selling price and maximises the use of observable inputs. The entity is required to apply estimation methods consistently in similar circumstances.
The new requirements for the allocation of the transaction price to performance obligations could result in a change in practice for many entities. IAS 18 did prescribe an allocation method for multiple-element arrangements. IFRIC 13 mentions two allocation methodologies: allocation based on relative fair value; and allocation using the residual method. However, IFRIC 13 did prescribe a hierarchy. As a result, entities used judgement to select the most appropriate methodology, taking into consideration all relevant facts and circumstances and ensuring the resulting allocation was consistent with IAS 18’s objective to measure revenue at the fair value of the consideration.
Given the limited guidance in current IFRS on multiple-element arrangements, entities look to the multiple-element arrangement literature in ASC 605-25 Revenue Recognition – Multiple-Element Arrangements to develop their accounting policies. The requirements in IFRS 15 are generally consistent with the estimation concepts in ASC 605-25, which set out a hierachy starting with vendor-specific objective evidence (VSOE), then third-party evidence and then best estimate of selling price for determining selling price for each unit of account. IFRS 15, however, does not require an entity to follow the hierarchy.
Some entities may find it difficult to determine a stand-alone selling price, particularly for goods or services for which the historical selling price is highly variable or for goods or services that have not yet been sold or are never sold separately. IFRS 15 says an entity may be able to estimate the stand-alone selling price of a performance obligation using a residual approach if:
- the entity sells the same good or service to different customers for a broad range of amounts (i.e., the selling price is highly variable); or
- the entity has not yet established a price for that good or service (i.e., the selling price is uncertain).
Under IFRS 15, entities are required to estimate the stand-alone selling price of options for additional goods or services that provide the customer with a material right. Instead of estimating the stand-alone selling price of an option, entities may apply a practical alternative provided in the standard when the optional goods or services are both:
- similar to the original goods and services in the contract; and Transaction price allocation
- provided in accordance with the terms of the original contract (which may be common for contract renewals).
Under this alternative, instead of valuing the option itself, the entity can assume the option is going to be exercised and include the optional additional goods and services (and related consideration) with the identified performance obligations when allocating the transaction price.