A manufacturer begins offering a new extended-monitoring service that it has never sold on a standalone basis. To estimate the standalone selling price for allocating the transaction price, the manufacturer forecasts the direct labor, materials, and overhead it expects to incur in providing the monitoring service over its term, and then adds a margin consistent with the margins it earns on services of similar risk and complexity. Under ASC 606-10-32-33(b), which method is the manufacturer using?
- The residual approach, which is available only when the good or service has a highly variable or uncertain price
- The expected cost plus a margin approach, which forecasts the entity's expected costs of satisfying the performance obligation and adds an appropriate margin for that good or service
- The adjusted market assessment approach, which relies primarily on observable competitor pricing in the market
- A cost-recovery method that defers all margin recognition until the total forecasted costs have been recovered in cash
Why B? And why not the others?
Correct answer: B. The expected cost plus a margin approach, which forecasts the entity's expected costs of satisfying the performance obligation and adds an appropriate margin for that good or service
ASC 606-10-32-33(b) describes the expected cost plus a margin approach as forecasting the entity's expected costs of satisfying a performance obligation and then adding an appropriate margin for that good or service, which matches exactly what the manufacturer is doing by building up its own forecasted direct and overhead costs for the monitoring service and layering on a margin consistent with similar offerings. The option describing the residual approach is wrong because that method, addressed separately in ASC 606-10-32-34, works by subtracting the observable standalone selling prices of a contract's other performance obligations from the total transaction price, and it is reserved for narrow situations involving highly variable or previously unestablished prices, not for a straightforward cost-plus-margin build-up. The option describing reliance on observable competitor pricing describes the adjusted market assessment approach in ASC 606-10-32-33(a), a distinct method that starts from the market rather than the entity's own cost structure. There is no cost-recovery method that defers margin recognition until costs are recovered in cash anywhere in ASC 606's standalone-selling-price guidance; that description conflates a cash-basis cost-recovery revenue model with the accrual-based estimation methods the standard actually provides.
Source: FASB Accounting Standards Codification: ASC 606-10-32-33(b), Revenue from Contracts with Customers — Estimating Standalone Selling Prices