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3 Determining and allocating the transaction

3.1 What is the transaction price where an entity includes a service

Reference to standing text: 11.77

Industry: Software

Entity A enters into a one-year contract (which is coterminous with entity A’s financial reporting period) with a customer to
provide access to its SaaS platform for a C1 million annual fee. The contract includes a service level agreement (SLA) that
the SaaS platform will maintain a 99.99% uptime during the year, or the customer will be entitled to a partial refund of the
annual fee. Based on its experience, entity A refunds on average approximately 5% of the annual fee under this guarantee.

Question

What is the transaction price in this arrangement?

Answer

The platform availability guarantee in the contract results in variable consideration.

Therefore, entity A should estimate the expected refund using either the expected value or most likely amount approach.
Entity A should also consider whether the transaction price should be constrained; that is, amounts should only be
included in the transaction price to the extent that it is highly probable that a significant reversal of the revenue recognised
will not occur once the uncertainty is resolved.

Entity A estimates the variable consideration based on the expected refund value of 5% and in making that estimate,
determines that it is highly probable that a significant reversal of the revenue recognised will not occur once the
uncertainty is resolved. The transaction price in this arrangement is C950,000 (C1 million annual fee less 5% estimated
refund).

In this case, the estimation uncertainty is resolved within the reporting period. However, there might be instances in
practice where the uncertainty is not resolved within the reporting period. In such cases, entities will need to update their
estimate of the refund at each reporting date until the uncertainty is resolved.

3.2 What factors should be considered in distinguishing between

Reference to standing text: 11.262

Industry: Software

Many software licence arrangements include a variable fee linked to usage of the software. It might not be clear whether
this fee is a usage-based royalty or a fee received in exchange for the purchase of additional rights by the customer. If a
software vendor is entitled to additional consideration based on the usage of software to which the customer already has
rights, without providing any additional or incremental rights, the fee is generally a usage-based royalty. In contrast, if a
software vendor provides additional or incremental rights that the customer did not previously control for an incremental
fee, the customer is likely exercising an option to acquire additional rights.

Judgement might be required to distinguish between a usage-based royalty (a form of variable consideration) and an
option to acquire additional rights. A usage-based royalty is recognised when the usage occurs or the performance
obligation is satisfied, whichever is later. Fees received when an option to acquire additional rights is exercised are
recognised when the additional rights are transferred; however, at contract inception, the software vendor would need to
assess whether the option provides a material right.

[IFRS 15 App B para B39].

Factors indicating that a variable fee is an option to purchase additional rights could include

The customer is making a separate purchasing decision (within its control) to

The customer is obtaining either (a) additional and incremental rights to use the
same software (such as additional seats or users) or (b) incremental functionality.
The customer benefits from the additional rights concurrently with existing rights;
that is, in exchange for the variable fee the customer receives an incremental
benefit as opposed to replacing usage that has been consumed.
Factors indicating that a variable fee is a usage-based fee could include:

The fee is incurred as a result of usage of the software that is not solely within the
customer’s control (for example, processing of transactions initiated by end
users).
The fee is incurred as a result of the customer’s use of the software to perform a
function or obtain an output.
None of the above factors is individually determinative, and there might be other relevant facts and circumstances to
consider.

The following examples illustrate the assessment of whether variable fees represent a usage-based royalty or an option to
acquire additional rights.

Example 1: Usage-based royalty

A software company licenses software to a customer that will be used by the customer to process transactions. The
licence permits the customer to grant an unlimited number of users access to the software for no additional fee. The
contract consideration includes a fixed upfront fee and a variable fee for each transaction processed using the software.

Question

How should the software company account for the variable fee?

Answer

The software company should account for the variable fee as a usage-based royalty. The incremental fees that the
software company receives are based on the usage of the software rights previously transferred to the customer. There
are no additional rights transferred to the customer; therefore, the software company should recognise the usage-based
royalty in the period the usage occurs.

Example 2: Option to acquire additional rights

On 1 January 20X7, a software company licenses to a customer the right to use its software for five years for a fixed price
of C1 million for 1,000 users (or ‘seats’). C1,000 per user is the current SSP for the software.

The contract also provides that the customer can add additional users during the term of the contract at a price of C800
per user. Management has concluded that each ‘seat’ is a separate performance obligation and, in substance, the
customer obtains an additional right when a new user is added.

On 1 January 20X8, the customer adds 20 users and pays the software company an additional C16,000.

Question

How should the software company account for the variable fee?

Answer

The variable fee in this arrangement is an option to purchase additional rights to use the software, because the rights for
the additional users are incremental to the rights transferred to the customer on 1 January 20X7. The software company
will need to assess whether the option provides a material right and, if so, allocate a portion of the C1 million transaction
price to the option. The amount allocated to the option would be deferred until the option is exercised or expires. In this
fact pattern, the discounted pricing of C800 per user, compared to the current pricing of C1,000 per user, might indicate
that the option provides a material right if the customer would not have received the discount without entering into the
current contract.

The software company would recognise the C16,000 fee for the additional rights when it transfers control of the additional
licences. The software company would also recognise amounts allocated to the related material right, if any, at the time
the right is exercised.

3.3 What factors should be considered in estimating SSP in a bundle of

Reference to standing text: 11.137

Industry: Software

Entity A sells software licences bundled with other goods or services, such as PCS. IFRS 15 requires an entity to allocate
the transaction price to the performance obligations based on their relative SSPs. However, entity A has no stand-alone
sales of a software licence.

Question

How should entity A estimate the SSP in the case of a software bundle?

Answer

IFRS 15 does not prescribe or prohibit any particular method for estimating SSP as long as the method results in an
estimate that faithfully represents the price a reporting entity would charge for the goods or services if they were sold
separately.

Software vendors often sell software licences bundled with other goods or services, such as PCS. IFRS 15 requires an
entity to allocate the transaction price to the performance obligations based on their relative SSPs. SSP is the price at
which an entity would sell a promised good or service separately. The best evidence of SSP is an observable price when
the good or service is sold on a stand-alone basis. There may be observable prices for PCS based on stand-alone renewal
transactions. An entity should consider its pricing policies and practices, and data used in making the pricing decisions,
maximising the use of observable inputs. However, a software vendor often has limited, if any, stand-alone sales of a
software licence. Often, an entity may conclude that a market-based approach or expected cost plus a reasonable margin
approach do not provide reliable information for determining SSP in a licence and PCS bundle. In this case, alternative
approaches to estimating the SSP may be used.

Percentage relationship approach

One way of estimating the SSP of the PCS in a software bundle would be to consider the relationship between the prices
of the licence and the PCS. It might be reasonable for an entity to conclude that there is a value relationship between the
licence and PCS that could be used to establish SSPif the entity has historically and consistently priced PCS as a
percentage of the licence fee for both the initial purchase and renewals. For example, an entity may determine that PCS is
historically and consistently priced at 20% of the licence fee.

Residual approach

A software vendor may estimate the SSP of a good or service using the “residual approach” when the SSP of a promised
good or service is highly variable or uncertain. The residual approach should only be used when the entity sells the same
good or service to different customers for a broad range of prices, making them highly variable, or when the entity has not
yet established a price for a good or service because it has not been previously sold. Before concluding that SSP for a
software licence will be estimated using the residual approach, the entity should first consider whether another method
can be used to estimate SSP by maximising the use of observable inputs, if any. An entity that does not licence software
separately should consider whether the pricing of its bundled arrangements (for example, software licences and PCS) is
highly variable. There are no bright lines for assessing whether pricing is highly variable; therefore this analysis will require
judgement and could include both qualitative and quantitative data. An entity should document its methodology for
evaluating pricing variability and apply that methodology consistently.

In applying the residual approach, an entity would calculate the estimated SSP of the software licence by subtracting the
sum of observable SSPs of other goods or services in the arrangement (for example, PCS). The entity would then use the
estimated SSP of the software licence in the relative SSP allocation.

When the residual approach is used, an entity still needs to compare the results obtained to all reasonably available
observable evidence to ensure the method meets the objective of allocating the transaction price based on SSP.
Allocating little or no consideration to a performance obligation suggests the method used might not be appropriate,
because a good or service that is distinct is presumed to have value to the purchaser. Reasonable evidence for a software
arrangement could include:

the entity’s pricing policies and strategy;

3.4 How should an entity estimate SSP where the residual approach is
not appropriate?
Reference to standard: IFRS 15 para 79(c)

Reference to standing text: 11.137

Industry: Software

A software company enters into a contract with a customer to licence software and provide PCS for a total transaction
price of C1.1 million. The software company regularly sells PCS for C1 million on a stand-alone basis. The software
company also regularly licenses software on a stand-alone basis for a price that is highly variable, ranging from C500,000
to C5 million.

Question

Can the software company use the residual approach to determine the SSP of the software licence?

Answer

No. Since the seller has observable evidence that PCS sells for C1 million, the residual approach results in a nominal
allocation of selling price to the software licence. As the software is typically sold separately for C500,000 to C5 million,
this is not an estimate that faithfully represents the price of the software licence if it was sold separately. As such, the
allocation objective of the standard is not met, and the software company should use another method to estimate the SSP
of the licence.

3.5 Allocating variable consideration to a series: how should variable

Reference to standing text: 11.148

Industry: Software

Entity B enters into a two-year contract with a customer whereby entity B will process all transactions on behalf of the
customer. The customer is obligated to use entity B’s system to process all of its transactions; however, the ultimate
quantity of transactions is unknown. Entity B charges the customer a monthly fee calculated as C0.03 per transaction
processed during the month.

Entity B concludes that the nature of its promise is a series of distinct monthly processing services and accounts for the
two-year contract as a single performance obligation.

Question

How should entity B allocate the variable consideration in this arrangement?

Answer

Entity B should allocate the variable monthly fee to the distinct monthly service to which it relates, assuming the results
are consistent with the allocation objective. Entity B would determine that the allocation objective is met because the fees
are priced consistently throughout the contract and the rates are consistent with the entity’s pricing practices with similar
customers.

Assessing whether the allocation objective is met will require judgement. For example, if the rate per transaction
processed was not consistent throughout the contract, entity B would have to evaluate the reasons for the varying rates to
assess whether the results of allocating each month’s fee to the monthly service are reasonable. Entity B should consider,
among other factors, whether the rates are based on market terms and whether changes in the rate are substantive and
linked to changes in value provided to the customer. For example, if the terms were structured to simply recognise more
revenue earlier in the contract, this is a circumstance when the allocation objective would not be met. Management should
also consider whether arrangements with declining prices include a future discount for which revenue should be deferred.

3.6 Allocating variable consideration to a series: how should revenue be

Reference to standing text: 11.148

Industry: Software

Entity A enters into a contract to provide a customer with a cloud-based solution to process payroll over a one-year
period. The customer cannot take possession of the software at any time during the hosting period; therefore, the contract
does not include a licence. Entity A charges the customer an upfront fee of C1 million and a monthly fee of C2 for each
employee’s payroll processed through the cloud-based solution. If the customer renews the contract, it will have to pay a
similar upfront fee.

Entity A concludes that the nature of its promise is a series of distinct monthly services, and it accounts for the one-year
contract as a single performance obligation.

In the first quarter of the year, the monthly fees for payroll processed in January, February and March are C50,000,
C51,000 and C52,000, respectively.

Question

How should Entity A recognise revenue from this arrangement?

Answer

Entity A should determine an appropriate measure of progress to recognise the C1 million upfront fee, which would likely
be a time-based measure (that is, ratable recognition over the contract term). Entity A should allocate the variable monthly
fees to the distinct monthly service to which they relate (that is, C50,000 to January, C51,000 to February, and C52,000 to
March). The allocation objective is met, because the C2 monthly fee per employee is consistent throughout the contract
and the variable consideration can be allocated to the distinct service to which it relates, which is the monthly payroll
processing service in January, February and March.

The resulting accounting is that the upfront fee is spread ratably, but the variable fee is not. This does not mean that the
entity is using multiple measures of progress. The single measure of progress for the contract is a time-based measure,
but the variable fee is allocated to specific time periods in accordance with the allocation guidance in paragraph 85 of
IFRS 15.

3.7 Allocating variable consideration to a series: how should an entity

Reference to standing text: 11.148

Industry: Software

SaaS will typically meet the criteria to be accounted for as a series of distinct goods or services and therefore be
considered a single performance obligation. To meet the criteria to be accounted for as a series pursuant to paragraph 23
of IFRS 15, the distinct goods or services provided must both (a) be substantially the same and (b) have the same pattern
of transfer to the customer. These criteria are often met with a SaaS arrangement because each distinct service (for
example, each day of service) is substantially the same, and have the same pattern of transfer to the customer.

Question

How should a SaaS vendor assess whether it is appropriate to allocate variable consideration received in a SaaS to
distinct services within a series?

Answer

When the arrangement includes variable consideration (for example, a usage-based fee), the SaaS vendor should apply
the guidance in paragraph 85 of IFRS 15 to determine whether the variable consideration should be allocated entirely to a
distinct service within the series. A SaaS provider will need to determine whether the arrangement is (a) a promise to
provide access to the SaaS, or (b) a promise to provide a specified amount of services. (See section 4.9 “How should
revenue be recognised for an arrangement to provide access to SaaS where the contract includes scheduled increases in
the fee on an annual basis?”)

A common example is a SaaS arrangement with a variable fee based on daily usage of the SaaS platform. The criteria in
paragraph 85 of IFRS 15 are used to determine whether the daily fee (variable consideration) should be allocated to the
day to which it relates (a distinct service within the series). If the criteria are met, the daily fee is recognised each day as
the usage occurs (see section 3.6 “Allocating variable consideration to a series: how should revenue be recognised for a
contract with an upfront fee?”).

The first requirement will often be met for usage-based fees because the terms of the variable fee relate to the period the
customer is receiving benefit from the SaaS. More judgement may be required to assess whether allocation of the fee to
the period of usage is consistent with the allocation objective. The allocation objective would likely be met if:

the usage-based fee is consistent throughout the contract period (for example, a
per-usage fee for each transaction processed), and
a usage-based fee is incurred each reporting period.
If the usage-based fee is not consistent throughout the contract term (for example, the per-usage fee ranges significantly
from period to period), allocating the fee to the period of usage may not be consistent with the allocation objective,
depending on the reasons for the varying fee.

If the criteria are not met, the variable consideration is estimated and included in the total transaction price, which is
recognised using the measure of progress determined for the SaaS arrangement (for example, ratably over the SaaS
contract term if a time-based measure of progress is utilised).

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