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5.3 Standalone selling price not directly observable
Publication date: 28 Feb 2022
us Revenue guide 5.3
The standalone selling price of an item that is not directly observable must be estimated. The revenue standard does not prescribe or prohibit any particular method for estimating the standalone selling price, as long as the method results in an estimate that faithfully represents the price a reporting entity would charge for the goods or services if they were sold separately.
There is also no hierarchy for how to estimate or otherwise determine the standalone selling price for goods or services that are not sold separately. Management should consider all information that is reasonably available and should maximize the use of observable inputs. For example, if a reporting entity does not sell a particular good on a standalone basis, but its competitors do, that might provide data useful in estimating the standalone selling price.
Standalone selling prices can be estimated in a number of ways. Management should consider the reporting entity's pricing policies and practices, and the data used in making pricing decisions, when determining the most appropriate estimation method. The method used should be applied consistently to similar arrangements. Suitable methods include, but are not limited to:
• Adjusted market assessment approach (RR 5.3.1)
• Expected cost plus a margin approach (RR 5.3.2)
• Residual approach, in limited circumstances (RR 5.3.3)
Question RR 5-2 addresses whether a reporting entity could assert it is unable to estimate standalone selling price.
Question RR 5-2
Are there instances when a reporting entity could assert it is unable to estimate standalone selling price?
Are there instances when a reporting entity could assert it is unable to estimate standalone selling price?
PwC response
No. The revenue standard requires a reporting entity to estimate standalone selling price for each distinct good or service in an arrangement. The residual approach (refer to RR 5.3.3) may only be used if specific criteria are met.
5.3.1 Adjusted market assessment approach
A market assessment approach considers the market in which the good or service is sold and estimates the price that a customer in that market would be willing to pay. Management should consider a competitor's pricing for similar goods or services in the market, adjusted for entity-specific factors, when using this approach. Entity-specific factors might include:
• Position in the market
• Expected profit margin
• Customer or geographic segments
• Distribution channel
• Cost structure
A reporting entity that has a greater market share, for example, may charge a lower price because of those higher volumes. A reporting entity that has a smaller market share may need to consider the profit margins it would need to receive to make the arrangement profitable. Management should also consider the customer base in a particular geography. Pricing of goods and services might differ significantly from one area to the next, depending on, for example, distribution costs.
Market conditions can also affect the price for which a reporting entity would sell its product including:
• Supply and demand
• Competition
• Market perception
• Trends
• Geography-specific factors
A single good or service could have more than one standalone selling price if it is sold in multiple markets. For example, the standalone selling price of a good in a densely populated area could be different from the standalone selling price of a similar good in a rural area. A large number of competitors in a market can result in a reporting entity having to charge a lower price in that market to stay competitive, while it can charge a higher price in markets where customers have fewer options.
Reporting entities might also employ different marketing strategies in different regions and therefore be willing to accept a lower price in a certain market. A reporting entity whose brand is perceived as top-of-the-line may be able to charge a price that provides a higher margin on goods or services than one that has a less well-known brand name.
Discounts offered by a reporting entity when a good or service is sold separately should be considered when estimating standalone selling prices. For example, a sales force may have a standard list price for products and services, but regularly enter into sales transactions at amounts below the list price. Management should consider whether it is appropriate to use the list price in its analysis of standalone selling price if the reporting entity regularly provides a discount.
Management should also consider whether the reporting entity has a practice of providing price concessions. A reporting entity with a history of providing price concessions on certain goods or services needs to determine the potential range of prices it expects to charge for a product or service on a standalone basis when estimating standalone selling price.
The significance of each data point in the analysis will vary depending on a reporting entity's facts and circumstances. Certain information could be more relevant than other information depending on the reporting entity, the location, and other factors.
5.3.2 Expected cost plus a margin
An expected cost plus a margin approach (“cost-plus approach”) could be the most appropriate estimation method in some circumstances. Costs included in the estimate should be consistent with those a reporting entity would normally consider in setting standalone prices. Both direct and indirect costs should be considered, but judgment is needed to determine the extent of costs that should be included. Internal costs, such as research and development costs that the reporting entity would expect to recover through its sales, might also need to be considered.
Factors to consider when assessing if a margin is reasonable could include:
• Margins achieved on standalone sales of similar products
• Market data related to historical margins within an industry
• Industry sales price averages
• Market conditions
• Profit objectives
The objective is to determine what factors and conditions affect what a reporting entity would be able to charge in a particular market. Judgment will often be needed to determine an appropriate margin, particularly when sufficient historical data is not readily available or when a product or service has not been previously sold on a standalone basis. Estimating a reasonable margin will often require an assessment of both entity-specific and market factors.
Example RR 5-3 illustrates some of the approaches to estimating standalone selling price.
EXAMPLE RR 5-3
Allocating transaction price – standalone selling prices are not directly observable
Biotech enters into an arrangement to provide a license and research services to Pharma. The license and the services are each distinct and therefore accounted for as separate performance obligations, and neither is sold individually.
What factors might Biotech consider when estimating the standalone selling prices for these items?
Analysis
Biotech analyzes the transaction as follows:
License
The best model for determining standalone selling price will depend on the rights associated with the license, the stage of development of the technology, and the nature of the license itself.
A reporting entity that does not sell comparable licenses may need to consider factors such as projected cash flows from the license to estimate the standalone selling price of a license, particularly when that license is already in use or is expected to be exploited in a relatively short timeframe. A cost-plus approach may be more relevant for licenses in the early stage of their life cycle where reliable forecasts of revenue or cash flows do not exist. Determining the most appropriate approach will depend on facts and circumstances as well as the extent of observable selling-price information.
Research services
A cost-plus approach that considers the level of effort necessary to perform the research services would be an appropriate method to estimate the standalone selling price of the research services. This could include costs for full-time equivalent (FTE) employees and expected resources to be committed. Key areas of judgment include the selection of FTE rates, estimated profit margins, and comparisons to similar services offered in the marketplace.
5.3.3 Residual approach
The residual approach involves deducting from the total transaction price the sum of the estimated standalone selling prices of other goods and services in the contract to estimate a standalone selling price for the remaining goods or services. Use of a residual approach to estimate standalone selling price is permitted in certain circumstances.
Residual approach—an entity may estimate the standalone selling price by reference to the total transaction price less the sum of the observable standalone selling prices of other goods or services promised in the contract. However, an entity may use a residual approach to estimate … the standalone selling price of a good or service only if one of the following criteria is met:
1. The entity sells the same good or service to different customers (at or near the same time) for a broad range of amounts (that is, the selling price is highly variable because a representative standalone selling price is not discernible from past transactions or other observable evidence).
2. The entity has not yet established a price for that good or service, and the good or service has not previously been sold on a standalone basis (that is, the selling price is uncertain).
5.3.3.1 When the residual approach can be used
A residual approach should only be used when the reporting entity sells the same good or service to different customers for a broad range of prices, making them highly variable, or when the reporting entity has not yet established a price for a good or service because it has not been previously sold. This might be more common for sales of intellectual property or other intangible assets than for sales of tangible goods or services.
The circumstances where the residual approach can be used are intentionally limited. Management should consider whether another method provides a reasonable estimate of the standalone selling price before using the residual approach.
5.3.3.2 Additional considerations for the residual approach
Arrangements could include three or more performance obligations with more than one of the obligations having a standalone selling price that is highly variable or uncertain. A residual approach can be used in this situation to allocate a portion of the transaction price to those performance obligations with prices that are highly variable or uncertain, as a group. Management will then need to use another method to estimate the individual standalone selling prices of those obligations. The revenue standard does not provide specific guidance about the technique or method that should be used to make this estimate.
Excerpt from ASC 606-10-32-35
A combination of methods may need to be used to estimate the standalone selling prices of the goods or services promised in the contract if two or more of those goods or services have highly variable or uncertain standalone selling prices. For example, an entity may use a residual approach to estimate the aggregate standalone selling price for those promised goods or services with highly variable or uncertain standalone selling prices and then use another method to estimate the standalone selling prices of the individual goods or services relative to that estimated aggregate standalone selling price determined by the residual approach.
When a residual approach is used, management still needs to compare the results obtained to all reasonably available observable evidence to ensure the method meets the objective of allocating the transaction price based on standalone selling prices. Allocating little or no consideration to a performance obligation suggests the method used might not be appropriate, because a good or service that is distinct is presumed to have value to the purchaser.
Example RR 5-4 and Example RR 5-5 illustrate the use of the residual approach to estimate standalone selling price.
EXAMPLE RR 5-4
Estimating standalone selling price – residual approach
Seller enters into a contract with a customer to sell Products A, B, and C for a total transaction price of $100,000. On a standalone basis, Seller regularly sells Product A for $25,000 and Product B for $45,000. Product C is a new product that has not been sold previously, has no established price, and is not sold by competitors in the market. Products A and B are not regularly sold together at a discounted price. Product C is delivered on March 1, and Products A and B are delivered on April 1.
How should Seller determine the standalone selling price of Product C?
Analysis
Seller can use the residual approach to estimate the standalone selling price of Product C because Seller has not previously sold or established a price for Product C. Prior to using the residual approach, Seller should assess whether any other observable data exists to estimate the standalone selling price. For example, although Product C is a new product, Seller may be able to estimate a standalone selling price through other methods, such as using expected cost plus a margin.
Seller has observable evidence that Products A and B sell for $25,000 and $45,000, respectively, for a total of $70,000. The residual approach would result in an estimated standalone selling price of $30,000 for Product C ($100,000 total transaction price less $70,000).
EXAMPLE RR 5-5
Estimating standalone selling price – residual approach is not appropriate
SoftwareCo enters into a contract with a customer to license software and provide post-contract customer support (PCS) for a total transaction price of $1.1 million. SoftwareCo regularly sells PCS for $1 million on a standalone basis. SoftwareCo also regularly licenses software on a standalone basis for a price that is highly variable, ranging from $500,000 to $5 million.
Can SoftwareCo use the residual approach to determine the standalone selling price of the software license?
Analysis
No. Because the seller has observable evidence that PCS sells for $1 million, the residual approach results in a nominal allocation of selling price to the software license. As the software is typically sold separately for $500,000 to $5 million, this is not an estimate that faithfully represents the price of the software license if it was sold separately. As such, the allocation objective of the standard is not met and SoftwareCo should use another method to estimate the standalone selling price of the license.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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