A contract includes three distinct performance obligations. Two of them have standalone selling prices that are directly observable from the entity's regular sales. The third is a highly customized service the entity has never priced or sold separately, and its selling price is known to vary widely and is uncertain until finalized for each customer. Under ASC 606-10-32-34, which approach may the entity use to estimate the standalone selling price of the third performance obligation?
- The adjusted market assessment approach, using only competitor pricing for similar services in the open market
- The expected cost plus a margin approach, applied identically regardless of how variable or uncertain the price is
- No estimate is permitted; the entity must decline to allocate any transaction price to a performance obligation whose standalone selling price is not directly observable
- The residual approach, subtracting the sum of the observable standalone selling prices of the other performance obligations from the total transaction price to derive the remaining amount
Why D? And why not the others?
Correct answer: D. The residual approach, subtracting the sum of the observable standalone selling prices of the other performance obligations from the total transaction price to derive the remaining amount
ASC 606-10-32-34 permits the residual approach as a suitable method for estimating standalone selling price only in narrow circumstances, including when the entity has not previously sold the good or service and has not yet established a price for it, so its selling price is uncertain, or when the entity sells the same good or service to different customers at prices that vary widely. The described customized service, with a genuinely uncertain and widely varying price, fits that narrow condition, so the entity subtracts the sum of the observable standalone selling prices of the other performance obligations from the total transaction price and treats the remainder as the estimate for the unobservable one. The adjusted market assessment approach instead relies on evaluating the market in which the entity sells and estimating what customers would be willing to pay, using the entity's own competitive positioning rather than competitor pricing alone, so restricting it to only competitor prices misstates the method. Expected cost plus a margin is one of several acceptable estimation methods generally, but ASC 606 does not require or permit applying it identically without regard to how variable or uncertain a price is; the standard explicitly reserves the residual approach for exactly this kind of high variability or uncertainty. Refusing to allocate any price to a performance obligation with no directly observable standalone selling price would contradict the core allocation objective of ASC 606, which requires the full transaction price to be allocated across all performance obligations using the best available estimation method, not withheld.
Source: FASB Accounting Standards Codification: ASC 606-10-32-34, Revenue from Contracts with Customers — Estimating Standalone Selling Prices