How should a transaction price for multiple performance obligations in a contract be allocated according to the revenue recognition principle?

• A. Equally among all performance obligations
• B. According to the estimated costs incurred for each obligation
• C. At the discretion of management
• D. Based on the relative standalone selling prices of each performance obligation

Answer: (D)

Verified step by step guidance

1. Understand the concept of performance obligations: A performance obligation is a promise in a contract to transfer goods or services to a customer. Multiple performance obligations exist when a contract includes distinct goods or services that are separately identifiable.
2. Review the revenue recognition principle: This principle requires that revenue be recognized when control of goods or services is transferred to the customer, and the amount of revenue recognized should reflect the consideration the entity expects to receive.
3. Learn the allocation method: The transaction price for a contract with multiple performance obligations must be allocated based on the relative standalone selling prices of each performance obligation. This ensures that revenue is recognized proportionally to the value of each obligation.
4. Determine standalone selling prices: Standalone selling prices are the prices at which an entity would sell a good or service separately to a customer. If the standalone selling price is not directly observable, it can be estimated using methods such as the adjusted market assessment approach, expected cost plus margin approach, or residual approach.
5. Allocate the transaction price: Once the standalone selling prices are determined, calculate the proportion of the total transaction price attributable to each performance obligation using the formula: \( \text{Allocation} = \frac{\text{Standalone Selling Price of Obligation}}{\text{Sum of Standalone Selling Prices}} \times \text{Total Transaction Price} \).