Meridian Cloud Solutions: Allocating a €3.6m Bundled Software Contract
On 1 January 2026 Meridian Cloud Solutions, a software vendor, signs a three-year contract with a customer for fixed consideration of €3.6m, payable €1.2m on signing and €0.8m on each anniversary. The contract bundles: (i) a perpetual on-premise licence to Meridian's core platform, delivered on day one; (ii) hosted managed services supplied over the three years; and (iii) all future version upgrades to the on-premise platform, for which the customer would otherwise pay a separate annual fee. The licence can run on the customer's own servers or on a third-party cloud, and the customer evaluated both options before signing. Meridian's estimated standalone selling prices are €1.4m for the licence, €1.7m for the hosting and €0.6m for the upgrade right. Meridian incurs €120,000 of incremental cost to win the contract and €90,000 of recoverable set-up cost. The customer may terminate at the first anniversary by paying 40% of the remaining fees.
1. Identify the performance obligations and allocate the €3.6m transaction price. State the steps you applied and the amounts.
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Step 1: identify the contract - enforceable, commercial substance, collection probable, so it meets the criteria once signed. Step 2: identify performance obligations. The licence is distinct: the customer can benefit from it with readily available resources (its own servers or a third-party cloud), it is separately identifiable in the contract, and the hosting does not significantly modify or customise it. Hosting is a separate service. The promise of 'all future version upgrades' is a material right: without the contract the customer would pay an annual fee for upgrades, so the option conveys a right it would not otherwise receive, and it is a separate performance obligation. Step 3: transaction price is the fixed €3.6m - no variable consideration, no significant financing component given annual payments over three years.
Step 4: allocate on relative standalone selling prices. Total SSP = 1.4 + 1.7 + 0.6 = €3.7m, so the contract is at a small discount that is allocated pro rata:
- Licence: 3.6 × 1.4/3.7 = €1.362m
- Hosting: 3.6 × 1.7/3.7 = €1.654m
- Upgrade right: 3.6 × 0.6/3.7 = €0.584m
Total €3.600m. The allocation must use the SSP estimates consistently and be re-assessed if they change; a change in SSP after inception is not applied retrospectively to a completed allocation.
2. When is revenue recognised for each obligation, and how would you treat the two contract costs?
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Licence: recognised at a point in time, on delivery on 1 January 2026. The customer obtains control then - it can direct the use of, and obtain substantially all remaining benefits from, the licence, and Meridian has no continuing obligation to update the on-premise software beyond the separate upgrade right. €1.362m hits revenue in 2026.
Hosting: recognised over time, because the customer simultaneously receives and consumes the benefit as Meridian performs. €1.654m spread over 36 months, about €45,900 per month, regardless of the cash collection profile.
Upgrade right: the €0.584m is recognised as the right is satisfied - either when the upgrades are transferred, or on a systematic basis over the three years if Meridian is continuously obliged to make upgrades available. The chosen policy must reflect the substance and be applied consistently; the key is that it is not recognised in full at inception.
Costs: the €120,000 incremental cost of obtaining the contract is capitalised and amortised on a basis consistent with the pattern of transfer of the related goods and services - broadly €40,000 a year over three years. The €90,000 set-up cost is a fulfilment cost: it relates directly to the contract, generates resources used to satisfy the hosting obligation and is recoverable, so it is capitalised (unless another standard applies) and amortised over the same period. Both assets must be tested for impairment if the contract is modified or terminated early.
3. Does the 40% termination penalty mean the contract term is three years? Explain the consequence of your conclusion for the hosting revenue and the contract cost assets.
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The term of the contract for IFRS 15 purposes is the period over which the parties have enforceable rights and obligations. A termination penalty is relevant because it makes termination uneconomic and can extend the enforceable period beyond the contractual notice period - but only if it is substantive.
Here the penalty at the end of year one would be 40% of the €2.4m of remaining fees, €0.96m. That is a substantial economic deterrent for a customer of this size who has also invested in an on-premise deployment; it is not a nominal break fee. The conclusion should therefore be a three-year contract term, which is consistent with the allocation above.
The consequence if you concluded otherwise is not trivial. If the enforceable period were one year, the hosting revenue (and the upgrade right) would be recognised over 12 months rather than 36 - roughly €1.65m and €0.58m accelerated into 2026 - and the contract cost assets would be amortised over one year, sharply front-loading cost. Profit in 2026 would be materially distorted. Document the penalty assessment and the quantitative analysis supporting 'substantive', and revisit it if the customer has a realistic practical ability to terminate without penalty, for example through a change-of-control or exit clause buried in the master agreement.