The option would then be included in the relative standalone selling price allocation. In this example,
there would be two performance obligations, one year of warranty services and one option for
discounted renewals. The contract consideration of $750 would be allocated between those two
performance obligations based on their relative standalone selling prices.
Example 49 in the standard (included in section 4.6) illustrates the estimation of the standalone selling
price of an option determined to be a material right under ASC 606-10-55-44.
Scenario B — Practical alternative to estimating the standalone selling price of the option using the
renewal option approach (ASC 606-10-55-45)
If the entity chooses to use the renewal option approach, it would allocate the transaction price to the
option for warranty services by reference to the warranty services expected to be provided (including
expected renewals) and the corresponding expected consideration. Since there is a discount offered
on renewal of the warranty service, this calculation will result in less revenue being allocated to the
first year of the warranty service than the amount of consideration received for the first year of service
(i.e., an amount less than $750). The difference between the consideration received (or that will be
received) for the first year of warranty service (i.e., $750) and the revenue allocated for the first year
of warranty service will represent the amount allocated to the option using the renewal option approach.
Assume the entity obtained 100 new subscribers under the promotion. Based on its experience, the entity
anticipates approximately 50% attrition annually, after also giving consideration to the anticipated effect
that the $150 discount will have on attrition. The entity considers the constraint on variable consideration
and concludes that it is probable that a significant revenue reversal will not occur. Therefore, the entity
concludes that for this portfolio of contracts, it will ultimately sell 175 one-year warranty services (100
+ 50 renewals after year one + 25 renewals after year two).
The total consideration the entity expects to receive is $120,000 [(100 x $750) + (50 x $600) + (25 x
$600)] (i.e., the hypothetical transaction price). Assuming the standalone selling price for each warranty
period is the same, the entity allocates $685.71 ($120,000/175) to each warranty period.
During the first year, the entity would recognize revenue of $68,571 (100 warranties sold times the
allocated price of $685.71 per warranty). Consequently, at contract inception, the entity would
allocate $6,429 to the option to renew ($75,000 cash received less $68,571 revenue to be
recognized in the first year).
If the actual renewals in years two and three differ from its expectations, the entity would have to
update the hypothetical transaction price and allocation accordingly. However, beyond stating, as
discussed in section 6.1, that the estimate of the standalone selling prices at contract inception for the
warranty service would not be updated, the standard is not explicit about how the entity should update
the hypothetical transaction price and allocation. Below is an illustration of how an entity could update its
practical alternative calculation based on a change in expectations.
For example, assume that the entity experiences less attrition than expected (e.g., 40% attrition annually
instead of 50%). Therefore, the entity estimates that it will ultimately sell 196 one-year warranty
services (100 + 60 renewals after year one + 36 renewals after year two). Accordingly, the total
consideration the entity expects to receive is $132,600 [(100 x $750) + (60 x $600) + (36 x $600)]
(i.e., the updated hypothetical transaction price). The entity would not update its estimates of the
standalone selling prices (which were assumed to be the same for each warranty period). As such, the
entity allocates $676.53 ($132,600/196) to each warranty period. The entity would reduce the amount
of revenue it recorded in year one by $918 ($68,571 — (100 x 676.53)) because the amount allocated
to the option should have been higher at contract inception.
See section 5.8 for another example of applying the practical alternative when the contract includes a
nonrefundable up-front fee that is deemed to be a material right.