There is a new Revenue Recognition standard that will need to be implemented for annual reporting periods beginning on or after December 15, 2018. The standard affects all entities—public, private, and not-for-profit — that record transactions using GAAP.
Retailers often encounter Transaction Price Allocations which under the new revenue recognition standard, may be recorded differently than the current practice.
Below is an example of the application of the new standard to a transaction price allocation to separate performance obligations:
Facts: KP Company has a customer loyalty program that rewards a customer with one customer loyalty point for every $10 of purchases. Each point is redeemable for a $1 discount on any future purchases.
During a reporting period, customers purchase products for $100,000 and earn 10,000 points redeemable for future purchases. The standalone selling price of the purchased products is $100,000. The entity expects 9,500 points to be redeemed. The entity estimates a standalone selling price of $0.95 per point (or $9,500 total) on the basis of the likelihood of redemption.
At the end of the first reporting period, 4,500 of the points have been redeemed, and the entity expects 9,500 points to be redeemed in total. During the second reporting period, an additional 4,000 points are redeemed (cumulative points redeemed are 8,500). The entity now expects that 9,700 points will be redeemed in total. In the third reporting period, an additional 1,200 points are redeemed (cumulative points redeemed are 9,700). KP Company expects that no additional points will be redeemed.
How should the transaction price be allocated to the separate performance obligations?
Analysis: The points provide a material right to customers that they would not receive without entering into a contract. Hence, KP concludes that the points are a separate performance obligation.
KP allocates the transaction price to the product and the points on a relative standalone selling price basis as follows:
- Product $91,324 (($100,000 x $100,000) / $109,500)
- Points $ 8,676 (($100,000 x $ 9,500) / $109,500)
At the end of the first period, KP recognizes revenue of $4,110 ((4,500 points / 9,500 points ) x $8,676). The cumulative revenue that the entity recognizes is $7,603 ((8,500 / 9,700) x $8,676).
In the second reporting period, KP recognizes revenue of $3,493 ($7,603 - $4,110) because it had recognized $4,110 in the first reporting period.
In the third reporting period, KP Company has already recognized revenue of $7,603, so it recognizes the remaining revenue of $1,073 ($8,676 - $7,603).