Question

9.3 Allocating the Transaction Price. HeavyEQ produces large conveyor belt systems for heavy manufacturing. HeavyEQ signs a $2 million fixed-price contract under which it makes three promises:

Install a conveyor belt system: fair value $1.6 million

Service the system over a five-year period: fair value $0.6 million

Provide a warranty assuring that the conveyer belt meets the contract specification at the time of sale: fair value $0.2 million

REQUIRED

a. Allocate the transaction price to the performance obligations.

b. Reallocate the transaction price under the notion that HeavyEQ has no reasonable basis for determining the fair value of the servicing because the conveyor system is of such a unique nature that the servicing activities are highly variable and uncertain.

Answer 1

A) Allocation of transfer price to the performnce obligation

Transaction price = $2 million

Performance obligation	Standalone selling price	Allocated Transaction proce
Conveyor Belt	$1.6 Million	$1.3333 million ($1.6/$2.4)*$2
Service	$0.6 million	$0.5 million ($0.6/$2.4)*$2
Warranty	$0.2 million	0.166667 Million ($0.2/$2.4)*$2
Total	$2.4 million	$2 Million

B) Reallocate the transaction price under the notion that HeavyEQ has no reasonable basis for determining the fair value of the servicing-

If stand-alone selling price/fair market value is not available, the entity must estimate the stand-alone selling price by using an approach that maximises the use of observable inputs and must apply estimation methods consistently in similar circumstances.

Some of suitable methods are

1. Adjustd Market Assessment approach: The adjusted market assessment approach involves the entity evaluating the market in which it sells goods or services, and estimating the price that a customer in that market would be willing to pay for those goods or services. This might also include referring to prices from the entity’s competitors for similar goods or services, and adjusting those prices as necessary to reflect the entity’s costs and margins.

2. Expected Cost plus Marin Approach: Under this approach the entity estimates the costs of satisfying the performance obligation, and then adds an appropriate margin.

3. Residual approach:

• Estimating the stand-alone selling price by reference to the total transaction price, and then deducting
• The sum of the observable stand-alone selling prices of other goods or services promised in the contract