Revenue Recognition on a Multi-Element Contract with Variable Consideration
Kestrel Software Ltd signs a 3-year contract on 1 July 2025 with a customer for a bundled package: a perpetual on-premise licence (standalone selling price $120,000), implementation services ($60,000 standalone), and 3 years of post-contract support ($90,000 standalone, being $30,000 per year). The total contract price is $240,000, payable $100,000 on signing and $70,000 on each anniversary. The contract also includes a performance bonus of up to $30,000, payable if the customer's transaction volumes exceed 5 million in any year; Kestrel's experience suggests a 70% likelihood of achieving the first threshold and no reliable basis to estimate beyond that. Implementation requires 400 hours and is highly integrated with the licence such that the customer cannot benefit from the licence without it. Kestrel's year end is 31 December 2025.
1. How should the $240,000 fixed consideration be allocated across the performance obligations, and how much revenue is recognised for the year ended 31 December 2025?
Read the worked answer
Step 1 - Identify performance obligations. The licence and implementation are a single combined performance obligation because the implementation is highly integrated and the customer cannot benefit from the licence without it. Support is a separate, distinct obligation provided over time. So there are two obligations: (a) licence + implementation (combined), and (b) support.
Step 2 - Allocate the fixed price on relative standalone selling prices (SSP).
- Combined SSP = $120,000 + $60,000 = $180,000
- Support SSP = $90,000
- Total SSP = $270,000
- Allocation to combined obligation = $240,000 × 180/270 = $160,000
- Allocation to support = $240,000 × 90/270 = $80,000
Step 3 - Variable consideration (bonus). Only include amounts for which a significant reversal is not highly probable. The 70% probability for the first threshold is not sufficient on its own - the constraint typically limits recognition to the amount that is highly probable. Without further evidence, the safest judgement is to exclude the bonus until the threshold is achieved. If included, it would be allocated on the same relative SSP basis.
Step 4 - Timing. The combined obligation transfers at a point in time (control passes on implementation completion, assumed to occur by 31 December 2025). Support is recognised straight-line over 3 years.
Step 5 - Revenue for year ended 31 December 2025.
- Combined obligation: $160,000 recognised on completion
- Support: $80,000 ÷ 3 = $26,667 for the year
- Total revenue = $186,667
Note the cash receipts ($170,000 by year end) are irrelevant to the revenue measure - they affect the contract liability/asset position. The contract liability at year end is $170,000 − $186,667 = negative, i.e. a contract asset of $16,667, because revenue exceeds billings.
2. The CFO argues the bonus should be recognised because '70% is more likely than not'. Evaluate this argument and state what additional evidence would change your conclusion.
Read the worked answer
The CFO is applying the wrong threshold. The 'more likely than not' (greater than 50%) test belongs to provisions and contingent liabilities, not to variable consideration under the revenue standard. For variable consideration, the constraint requires that it be highly probable that a significant reversal of cumulative revenue will not occur when the uncertainty resolves - effectively a much higher bar than 70%.
Relevant factors include:
- The amount of consideration is highly susceptible to factors outside Kestrel's influence (customer transaction volumes).
- Kestrel has no reliable basis to estimate beyond the first threshold, which increases estimation uncertainty.
- The experience period is limited and the bonus is a single large amount, not a portfolio of similar contracts.
On these facts, recognising the bonus would be premature. If Kestrel had a long history of similar contracts, a large portfolio of comparable arrangements, and stable volume data, the constraint might permit recognition of a portion. Even then, the amount recognised would be limited to the amount highly probable of not reversing - not the full $30,000.
Additional evidence that would change the conclusion: historical achievement rates across a large portfolio of comparable customers, contractual volume data showing the threshold has effectively been met, or a signed confirmation of volumes. Absent that, the bonus stays out of the transaction price and is revisited each reporting date.