Question

On what basis should the transaction price be allocated to various performance obligations? Identify the approaches for allocating the transaction price.

Short answer

The three ways for evaluating stand-alone selling price are:

(1) Adjusted market assessment approach

(2) Expected cost plus a margin approach

(3) Residual approach

Step-by-step solution

Meaning of Transaction Price

Transaction pricing refers to the amount of remuneration a seller requires to sell certain goods or services to a customer, which the customer does not pay in cash.

Approaches for allocating the transaction price

When multiple performance requirements require a transaction price allocation, the allocation is made based on which goods or services the firm can sell on its own (called the stand-alone selling price). If computing the stand-alone selling price is not possible, then a company can use these three options to measure the transaction consideration or price.

1. Adjusted market assessment approach: The entity evaluates the market in which it offers products or services and estimates the price that a client in that market would be willing to pay for those goods or services. This might also entail comparing pricing for similar items or services from the entity's rivals and modifying those prices as needed to reflect the entity's expenses and margins.
2. Expected cost plus a margin approach: The entity analyses the expenses of meeting the performance requirement using the estimated cost-plus margin technique, then adds an appropriate margin.
3. Residual approach:The entity involved in the residual approach, such as estimating the stand-alone selling price using the total transaction price as a guide and then subtracting it and the total of the observable stand-alone selling prices of the contract's other items or services.