Brightline Software: Allocating a Bundled Licence, Configuration and Support Contract
Brightline Software Ltd (BSL), a Hong Kong company with a 31 December year-end, signed a contract on 1 January 20X5 to supply a customer with (i) a standard on-premise accounting software licence, (ii) a six-month configuration service, and (iii) three years of post-contract support (PCS). The software is fully functional without the configuration, which the customer's own IT team could perform using readily available resources. Total consideration is HK$9,000,000, payable in three equal annual instalments of HK$3,000,000 on 31 December 20X5, 20X6 and 20X7. Standalone selling prices are: licence HK$5,000,000; configuration HK$2,000,000; PCS HK$3,000,000. BSL also promised a rebate of 5% of the licence fee (HK$250,000) if the customer buys more than HK$2,000,000 of consumables from BSL in any contract year; at inception BSL concludes it is highly probable that HK$150,000 of the rebate will not reverse. BSL pays its salesperson a commission of HK$180,000 that is incremental to obtaining the contract. BSL's incremental borrowing rate is 5%.
1. Identify the performance obligations in the contract and determine whether the licence transfers at a point in time or over time.
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Performance obligations. Three distinct promises should be assessed under HKFRS 15.26–30:
- Licence – the customer can benefit from the software together with readily available resources (its own IT team), and the licence is separately identifiable because BSL does not provide a significant integration service and the configuration does not significantly modify the software. It is distinct.
- Configuration – a separate service; the customer could perform it itself or use another provider, and it does not transform the licence into a combined output.
- PCS – distinct because it is a stand-alone support service that the customer could obtain from another provider and is not highly integrated with the licence.
Point in time or over time. The licence is a right to use BSL's intellectual property as it exists at the point in time the licence is granted. BSL does not undertake activities that significantly affect the IP, and the customer obtains substantially all of the remaining benefits from the licence on delivery. Revenue for the licence is therefore recognised at the point control transfers (delivery and acceptance), not over the three-year term.
The configuration is a service performed on the customer's environment; revenue is recognised over time as the service is performed (six months), because the customer receives and consumes the benefits as BSL performs. PCS is recognised over time on a straight-line basis over three years as the stand-ready service is provided.
2. Determine the transaction price, including the constraint on variable consideration and the significant financing component, and allocate it to the performance obligations.
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Step 1 – Significant financing component (HKFRS 15.60–65). The three HK$3,000,000 instalments over three years give the customer more than one year to pay, so the promised consideration must be discounted at 5%:
- 20X5: 3,000,000 / 1.05 = 2,857,143
- 20X6: 3,000,000 / 1.05² = 2,721,088
- 20X7: 3,000,000 / 1.05³ = 2,591,512
- Present value = HK$8,169,743
The difference between the cash of HK$9,000,000 and HK$8,169,743 (HK$830,257) is interest expense recognised over the three years using the effective interest method; it is not revenue.
Step 2 – Variable consideration (HKFRS 15.56–58). The rebate is variable consideration. BSL includes only HK$150,000 because that is the amount for which it is highly probable that no significant reversal will occur; the remaining HK$100,000 is constrained. The rebate relates specifically to the licence, so it is allocated entirely to the licence under HKFRS 15.84–85 rather than spread across all obligations.
Step 3 – Allocation. The fixed consideration of HK$8,169,743 is allocated in proportion to standalone selling prices (total HK$10,000,000):
| Obligation | SSP | % | Allocation |
|---|---|---|---|
| Licence | 5,000,000 | 50% | 4,084,871 |
| Configuration | 2,000,000 | 20% | 1,633,949 |
| PCS | 3,000,000 | 30% | 2,450,923 |
| Total | 10,000,000 | 100% | 8,169,743 |
Then deduct the constrained rebate of HK$150,000 from the licence: licence revenue allocated = HK$3,934,871. The total allocated transaction price is HK$8,019,743.
3. Explain how the HK$180,000 sales commission should be accounted for in 20X5 and later years.
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The commission is an incremental cost of obtaining a contract (HKFRS 15.91): BSL would not have incurred it if the contract had not been obtained, and it is expected to be recovered. It must be capitalised as a contract acquisition cost asset unless the practical expedient applies. The expedient is not available because the amortisation period (three years) exceeds one year.
The asset is amortised on a systematic basis consistent with the pattern of transfer of the goods or services to which it relates (HKFRS 15.99). A straight-line amortisation of HK$60,000 per year over three years is acceptable only if it reflects that pattern. A more faithful approach allocates the commission to the performance obligations on the same 50:20:30 basis used for revenue:
- Licence: HK$90,000 expensed when the licence transfers in 20X5;
- Configuration: HK$36,000 expensed over the six-month service in 20X5;
- PCS: HK$54,000 expensed over three years, i.e. HK$18,000 in 20X5.
On that basis HK$144,000 is expensed in 20X5 and HK$36,000 remains as an asset at 31 December 20X5. The key judgement is that amortisation must follow the transfer of the related services, not simply the passage of time.