How do you allocate revenue across multiple performance obligations in a single contract?

Question

AcadiFi · Accepted Answer

Multiple performance obligation contracts are common in technology, real estate, and telecom. IFRS 15 / ASC 606 requires identifying each distinct obligation and allocating the total price based on relative standalone selling prices (SSPs).

```mermaid
flowchart TD
    A[Single Contract: $2,400,000] --> B{Identify Distinct Obligations}
    B --> C[Software License]
    B --> D[Implementation Services]
    B --> E[2-Year Support]
    C --> F[SSP: $1,500,000]
    D --> G[SSP: $600,000]
    E --> H[SSP: $900,000]
    F --> I[Allocation: $1,200,000]
    G --> J[Allocation: $480,000]
    H --> K[Allocation: $720,000]
    I --> L[Point in Time]
    J --> M[Over Time: Input Method]
    K --> N[Over Time: Straight-Line]
```

**Step 1 — Identify Performance Obligations:**

A promised good or service is a separate performance obligation if:
1. The customer can benefit from it on its own or with readily available resources (capable of being distinct)
2. It is separately identifiable from other promises in the contract (distinct within the contract)

**Example:** Nexbridge Technologies signs a $2,400,000 contract with Aldermere Healthcare:
- Perpetual software license
- 6-month implementation/customization
- 2-year post-implementation support

Are these distinct? The software has standalone functionality (sold separately to other clients). Implementation is highly specialized but could be performed by a third party. Support is a standard offering. **All three are distinct obligations.**

However, if the customization is so intertwined that it significantly modifies the software, the license and implementation might be combined into one obligation.

**Step 2 — Determine Standalone Selling Prices:**

| Obligation | Observable SSP? | Method | SSP |
|---|---|---|---|
| Software license | Yes — sold separately | Direct | $1,500,000 |
| Implementation | No | Adjusted market assessment | $600,000 |
| Support | Yes — renewal price | Direct | $900,000 |
| **Total SSPs** | | | **$3,000,000** |

When SSP is not directly observable, use:
- **Adjusted market assessment:** Estimate what the market would pay
- **Expected cost plus margin:** Total expected costs plus a reasonable margin
- **Residual approach:** Only when SSP is highly variable or uncertain

**Step 3 — Allocate Transaction Price:**

Allocate based on relative SSPs:
- License: ($1,500,000 / $3,000,000) x $2,400,000 = **$1,200,000**
- Implementation: ($600,000 / $3,000,000) x $2,400,000 = **$480,000**
- Support: ($900,000 / $3,000,000) x $2,400,000 = **$720,000**

**Step 4 — Recognize Revenue:**
- License: At a point in time (when control transfers, likely at delivery)
- Implementation: Over time using input method (costs incurred / total estimated costs) over 6 months
- Support: Over time, straight-line over 24 months ($30,000/month)

**Analyst Considerations:**
- Companies with more bundled contracts have more judgment in SSP estimation — potential for manipulation
- Watch for changes in SSP estimates that shift revenue between periods
- Compare revenue recognition patterns across competitors for consistency

For bundled contract analysis practice, check our CFA Level II FRA course.

How do you allocate revenue across multiple performance obligations in a single contract?

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Related Questions

Practice Questions

Obligation	Observable SSP?	Method	SSP
Software license	Yes — sold separately	Direct	$1,500,000
Implementation	No	Adjusted market assessment	$600,000
Support	Yes — renewal price	Direct	$900,000
Total SSPs	$3,000,000