Revenue allocation for a bundled equipment, installation and support contract at CloudBridge Ltd
On 1 January 2024, CloudBridge Ltd signed a $1.7 million contract to supply equipment, install it and provide three years of support. The equipment's standalone selling price is $1.1 million, installation is $250,000 and support is $450,000. The customer can use the equipment without installation, and installation does not significantly modify or customise it. The customer obtains control of the equipment in March 2024, installation is completed in April 2024, and support begins when installation is complete. The contract includes a 5% rebate on the total contract price if the customer's purchases under a separate annual volume arrangement exceed $5 million by 31 December 2024. At inception, CloudBridge estimates a 70% chance of exceeding the threshold and uses the most likely amount; the expected rebate is $85,000. CloudBridge has no previous experience with this customer. At 31 December 2024, the customer had exceeded the threshold. CloudBridge has a 31 December year end.
1. Identify the performance obligations and allocate the transaction price at contract inception. Explain the treatment of the rebate at inception.
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The contract has three distinct performance obligations:
- Equipment, because the customer obtains control in March and can use it without installation.
- Installation, because it does not significantly modify or customise the equipment and is separately identifiable.
- Support, because it is provided over three years after installation.
At inception, the rebate is variable consideration. CloudBridge has no experience with this customer, the outcome depends on a separate volume arrangement and the 70% estimate could reverse. The constraint therefore prevents including the $85,000 rebate reduction in the transaction price. Transaction price at inception is $1.7m.
Relative standalone selling prices total $1.1m + $250,000 + $450,000 = $1.8m. Allocation:
- Equipment: $1.7m x 1.1/1.8 = $1.0389m.
- Installation: $1.7m x 0.25/1.8 = $236,100.
- Support: $1.7m x 0.45/1.8 = $425,000.
At inception, revenue is allocated on this basis, subject to updating the variable consideration when the constraint no longer applies.
2. Calculate revenue recognised in 2024 for each performance obligation after the rebate threshold is met. Show the updated allocation and any cumulative catch-up.
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At 31 December 2024 the threshold is met, so the $85,000 rebate is no longer constrained. The transaction price falls to $1.615m. Updated allocation using the same relative standalone selling prices:
- Equipment: $1.615m x 1.1/1.8 = $986,944.
- Installation: $1.615m x 0.25/1.8 = $224,306.
- Support: $1.615m x 0.45/1.8 = $403,750.
Revenue recognised in 2024:
- Equipment: $986,944, recognised when control passes in March.
- Installation: $224,306, recognised when installation is completed in April.
- Support: $403,750 x 9/36 = $100,938, because support runs for nine months from April to December 2024.
- Total 2024 revenue: $986,944 + $224,306 + $100,938 = $1,312,188.
The change from the inception allocation is a cumulative catch-up. Equipment and installation are fully recognised, so their reductions are adjusted immediately. Support revenue is adjusted only for the nine months recognised to date; the remaining reduction stays in the contract liability for future periods.
3. Explain why the rebate is constrained at inception but adjusted at year end, and state the journals for the catch-up.
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The constraint applies when it is highly probable that a significant reversal of cumulative revenue will not occur. At inception there is only a 70% estimate, no historical experience with this customer and a binary outcome. Including the rebate reduction would create a risk that revenue already recognised would have to be reversed, so the variable consideration is constrained.
By 31 December 2024 the threshold has actually been exceeded. The uncertainty is resolved, so the constraint no longer applies. The transaction price is updated and revenue is adjusted cumulatively.
The catch-up reduces equipment revenue by $1,038,889 - $986,944 = $51,945, installation revenue by $236,100 - $224,306 = $11,794 and support revenue by $106,250 - $100,938 = $5,312 for the nine months recognised. The remaining support reduction is a contract liability adjustment. The entry is to debit revenue and credit contract liability or refund liability for the cumulative amount, with the balance allocated to the remaining support obligation.