Software License, Implementation, Rebate, and Reseller Arrangement
Northwind Data Systems enters a three-year contract on 1 January 20X5. It promises a perpetual software license with a standalone selling price (SSP) of $900,000, implementation services with an SSP of $300,000, and post-contract support (PCS) with an SSP of $400,000. The license is transferred at inception; implementation is completed over four months and does not significantly modify or customize the software; PCS is delivered evenly over three years. Total consideration is $1,500,000, payable $500,000 at signing and $1,000,000 at the end of year 2. Northwind also promises a rebate of 5% of the license fee if the customer processes more than 2 million records in any year. Management estimates a 60% chance of exceeding the threshold and has no prior experience with this customer. Northwind sells similar hardware through a reseller that takes physical control, sets its own price, and has no right to return unsold units; Northwind has no repurchase right. On 1 November 20X5, the parties add a fourth year of PCS for $90,000; the SSP of that additional support is $120,000.
1. How should Northwind allocate the $1,500,000 transaction price, and when should each performance obligation be recognized? Address the rebate.
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Identify three performance obligations: the perpetual license, implementation, and PCS. They are distinct because the customer can benefit from the license together with implementation, implementation does not significantly modify or customize the software, and PCS is separately identifiable.
Allocate using relative SSP. Total SSP = $900,000 + $300,000 + $400,000 = $1,600,000. The $100,000 discount is allocated proportionately:
- License: $1,500,000 × 900/1,600 = $843,750
- Implementation: $1,500,000 × 300/1,600 = $281,250
- PCS: $1,500,000 × 400/1,600 = $375,000
Recognize the license at the point in time control transfers, which is inception for a perpetual license. Recognize implementation over the four-month service period if the services are provided over time; otherwise at completion. Recognize PCS evenly over three years.
The rebate is variable consideration. The expected rebate is 60% × 5% × $843,750 = $25,313. Because Northwind has no prior experience with this customer and a 60% likelihood is not 'highly probable,' the constraint likely prohibits recognizing the reduction until the uncertainty is resolved. The rebate relates specifically to the license, so any reduction would be allocated to the license, not to the other obligations. Reassess each reporting period; the payable schedule affects the significant-financing assessment, not the allocation.
2. Evaluate whether Northwind is principal or agent in the reseller arrangement and how that affects revenue recognition.
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The indicators point to Northwind being the principal. The reseller takes physical control of the hardware, sets its own price, and bears inventory risk because it cannot return unsold units. Northwind has no repurchase right and no continuing involvement that would indicate it retains control. The reseller is Northwind's customer.
As principal, Northwind recognizes revenue at the gross amount of consideration when control transfers to the reseller. It does not defer revenue until the reseller sells to an end user, and it does not treat the reseller's markup as variable consideration. If Northwind were an agent, it would recognize only its commission or fee net of the amount paid to the supplier. The facts here do not support net presentation because Northwind controls the hardware before transfer and the reseller has genuine pricing discretion and inventory risk.
3. Account for the 1 November 20X5 contract modification.
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The added fourth year of PCS is a distinct service, but the price of $90,000 is not its SSP of $120,000. Therefore, it is not a separate contract. Because the modification adds a distinct service at a discount, account for it as a termination of the existing contract and creation of a new contract on 1 November 20X5.
At modification date, 10 of 36 months of original PCS have been delivered. Recognized PCS revenue = $375,000 × 10/36 = $104,167. Remaining unrecognized PCS = $270,833. Add the $90,000 new consideration: total remaining consideration = $360,833.
Remaining service period = 26 months of original PCS plus 12 months of new PCS = 38 months. Recognize $360,833 / 38 = $9,496 per month prospectively. No catch-up adjustment is made to prior periods because the modification is treated as a new contract. If the modification had been priced at SSP, it would be a separate contract and the original PCS allocation would continue unchanged.