Revenue Recognition Timing on a Multi-Element Contract
On January 1, Year 1, Cobalt Systems signs a $1,200,000 contract with a customer to deliver a software license, install it, and provide three years of support. Standalone selling prices: license $900,000; installation $200,000; support $300,000 (total $1,400,000). The license has no standalone functionality until installation is complete; the customer cannot benefit from the license without the installation because the software is highly customized. Installation takes two months and is performed by Cobalt. Support begins when installation is complete. Cobalt has historically priced installation at a discount when bundled. Payment is $400,000 on signing, $400,000 at installation completion, and $400,000 at the end of Year 2. Cobalt's incremental borrowing rate is 6%.
1. Identify the performance obligations and determine how the transaction price is allocated.
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First assess whether the license and installation are distinct. The customer cannot benefit from the license without installation, and the installation significantly customizes the software. They are not separately identifiable, so license and installation combine into a single performance obligation. Support is distinct (customer can benefit with the other resources and it is separately identifiable).
Two performance obligations: (1) combined license + installation, SSP $1,100,000 ($900,000 + $200,000); (2) support, SSP $300,000. Total SSP $1,400,000.
Allocate the $1,200,000 transaction price by relative SSP:
- License + installation: $1,200,000 x (1,100/1,400) = $942,857
- Support: $1,200,000 x (300/1,400) = $257,143
A discount is allocated proportionately because there is no evidence it relates only to one obligation.
2. When is revenue recognized on each obligation, and how does the financing component affect the amounts?
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The combined license + installation obligation transfers when installation is complete (point in time, end of Month 2), because the customer obtains control only then. Recognize $942,857 at that date. Support is a stand-alone service transferred over time; recognize $257,143 ratably over 36 months, about $7,143 per month, starting when support begins.
The payment schedule does not align with performance. The $400,000 at signing is a year before installation; the final $400,000 is about 22 months after installation. The contract includes a significant financing component. The transaction price should be adjusted to present value using the 6% rate. The signing payment is financed by the customer to Cobalt (a liability), and the deferred final payment is financed by Cobalt to the customer (a receivable). Rather than restating the full present value computation, the key judgment is that the stated $1,200,000 is not the transaction price; interest is recognized separately as interest expense or income over the contract, and revenue excludes that interest. The practical expedient (one year or less) does not apply to the final payment because it exceeds one year from transfer of the related goods. If the period between transfer and payment were one year or less, the entity could elect the expedient.
3. In Year 2, Cobalt modifies the support to add an extra year at no additional charge. How should the modification be accounted for?
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A modification that adds a distinct service at a price that does not reflect its SSP is accounted for as a separate contract only if it adds distinct goods or services and the price increases by an amount commensurate with SSP. Here the price does not increase at all, so it is not a separate contract. Because the remaining support is distinct from the already-transferred license and installation, treat the modification as a termination of the existing support obligation and creation of a new one. Allocate the unrecognized portion of the original support consideration, plus any additional consideration (zero), over the remaining period including the added year. At the start of Year 2, roughly two years of support remain (24 months) and one year is added, so the remaining deferred support revenue is recognized over 36 months at a lower monthly rate. No cumulative catch-up adjustment to prior periods is needed because the remaining service is distinct.