Multiple Element Arrangements

Many business arrangements consist of multiple performance obligations within the same contract. Known as multiple-element arrangements, they entail more than one “output” or deliverable associated with the contract.

How businesses recognize revenue depends on the distinctiveness of each element in the arrangement, and whether they are considered to be separate performance obligations.

What are Multiple Element Arrangements? 

Multiple-element arrangements are business contracts that involve multiple distinct performance obligations (e.g., products, services, software licenses, or intellectual property rights).

Companies that offer product bundles, service add-ons, or other bundled offerings will often have multiple-element arrangements.

For example, when a company sells an item that includes both a physical product and an additional service (e.g., installation), it is considered a multiple-element arrangement.

In a multiple-element arrangement, every single unit must have a standalone value that can be objectively determined.

The multiple elements in an arrangement may be combined into one unit, but they must also be considered separate performance obligations.

Compared to contracts with a single performance obligation, multiple-element arrangements may also require different revenue recognition criteria to be met.

Synonyms

• Multiple Element Arrangements Under IFRS 15: IFRS 15 is an international accounting standard that deals with revenue recognition, and it covers multiple element arrangements.
• Bundled Sales: Arrangements where two or more separate products, services, and/or licenses are sold together at a bundled price.
• Bundled Contracts: Agreements that involve multiple performance obligations, such as products, services, and/or licenses.
• Revenue Arrangements With Multiple Deliverables: Agreements that require the seller to deliver multiple elements, such as products and/or services.

Revenue Recognition Policies for Multiple Element Arrangements

The timing of revenue recognition and the amount recognized for multiple-deliverable revenue arrangements differ from that of a single arrangement.

How exactly it is recognized depends on FASB revenue recognition rules (for US-based companies) and IFRS 15 (for international companies).

FASB

The Financial Accounting Standards Board (FASB) has set forth guidelines to address revenue recognition through Accounting Standards Codification (ASC) Topic 606: Revenue from Contracts with Customers.

ASC 606 is also known as the “converged revenue recognition standard” because it applies to both IFRS and US GAAP.

Step 1: Identify the contract with a customer.

Under ASC 606, a contract is a legally binding agreement between two or more parties that carries enforceable rights and responsibilities.

In the context of multiple-element arrangements, a contract exists when both parties have approved the agreement, committed to fulfilling their respective performance obligations, and the payment terms are clearly identified.

Step 2: Identify performance obligations in the contract.

A performance obligation is a promise to deliver goods or services to a customer.

In contracts with multiple deliverables, each performance obligation should be assessed separately, taking into consideration whether the good or service is distinct and can be separated from other goods or services in the contract.

Those that can (and historically have been) sold as standalone goods or services are considered separate performance obligations. Those that are not distinct must be combined and treated as a single performance obligation.

Step 3: Determine the transaction price.

The transaction price is the amount the business expects to receive in exchange for fulfilling its performance obligations (e.g., its contracted pricing). This may include fixed amounts, variable amounts, or a combination of both.

Variable amounts must be estimated based on either the expected value or the most likely amount, considering any uncertainties surrounding the amount the company may receive.

Step 4: Allocate each transaction price to the individual element.

Once the contracting process is complete (i.e., performance obligations and transaction prices have been determined, the transaction price must be allocated to each contractual element based on their standalone selling prices (i.e., the amount at which the business sells the element separately to a customer).

If a standalone selling price is not immediately discernible, the business may need to estimate it using appropriate methods, such as the cost-plus margin approach or the market assessment approach.

Step 5: Recognize revenue when each deliverable is satisfied.

Revenue is recognized when (or as) the business satisfies its performance obligations by transferring control of the promised goods or services to the customer.

The timing of revenue recognition depends on whether the performance obligation is satisfied at a point in time or over time.

If a contractual obligation is fulfilled over time, then revenue is recognized over time in proportion to the customer’s right to receive goods or services. For example, a subscription business may recognize revenue based on the value of services delivered in each accounting period throughout the subscription contract term.

If it is fulfilled at a point in time, then revenue is recognized when control of the goods or services has been transferred to the customer.

IFRS 15

To ensure consistency and transparency in financial reporting, the International Accounting Standards Board (IASB) has developed International Financial Reporting Standard 15 (IFRS 15): Revenue from Contracts with Customers.

Revenue Recognition Steps for International Multi-Deliverable Contracts

Similar to FASB accounting standards, international accounting standards require organizations to use a similar five-step model to recognize revenue for all multi-deliverable contracts.

However, additional considerations must be taken into account for accounting for international multi-deliverable contracts, such as currency exchange rate changes and foreign taxes.

The steps to recognize revenue are as follows:

1. Identify the contract and performance obligations. If there is more than one performance obligation, the company should determine whether each good or service is distinct (i.e., it can be distinguished from other goods or services).
2. Determine the transaction price. The transaction price includes any foreign exchange rate adjustments and is measured in the functional currency of the entity (e.g., Canadian dollars for a Canadian company). Any variable amounts related to the contract must be estimated based on either the expected value or most likely amount, considering any uncertainties.
3. Allocate the transaction price to each individual commitment. The prices for separate deliverables can be allocated based on their relative values (i.e., the amount at which they are sold separately).
4. Recognize revenue when (or as) each deliverable is satisfied. Revenue is recognized when, or as, performance obligations are satisfied by transferring control of the promised goods or services to the customer. This will depend on whether the performance obligation is fulfilled at once or throughout a contract.
5. Adjust for foreign exchange rate changes. Any adjustments related to foreign currency fluctuations should be recorded in the period that the exchange rate changed.

Additional Considerations for International Companies

When doing business internationally or across borders, there are a few additional considerations that must be taken into account when recognizing revenue.

1. Currency fluctuations: For international companies, currency fluctuations may impact the transaction price and require companies to account for these changes when recognizing revenue.
2. Local tax regulations: Companies must be aware of local tax regulations and consider the impact of taxes, such as value-added tax (VAT) or goods and services tax (GST), on the transaction price.
3. Cross-border transactions: International companies must consider the implications of cross-border transactions, such as import and export duties, customs regulations, and withholding taxes when recognizing revenue.

Example: Revenue Recognition for Multiple-Element Arrangements

To simplify the complicated topic of revenue recognition, here’s a quick example of how a business might recognize revenue for a contract with multiple deliverables.

1. Establish the contract (for instance, an agreement that includes installation and subsequent service).
2. Distinguish individual performance obligations (such as the initial installation, 12 routine inspections, and yearly upkeep).
3. Calculate the total transaction price for the entire agreement (for example, $125,000 covering all aspects).
4. Distribute the transaction price across the separate performance obligations (for instance, allocate $100,000 to the installation, $1,000 to each monthly inspection, and $13,000 to the yearly maintenance).
5. Acknowledge revenue as each obligation is fulfilled (for example, record $100,000 upon completing the installation, $1,000 each month following an inspection, and $13,000 after conducting the annual maintenance visit).

In the example above, some of this revenue may be paid upfront (i.e., deferred revenue). Still, the recognition of revenue takes place as each performance obligation is fulfilled.

Documentation Requirements for Multiple Element Arrangements

When it comes to multiple-element arrangements, companies must ensure that the accounting records provide enough evidence of the transactions to support their recognition and measurement of revenue.

Vendor-Specific Objective Evidence (VSOE)

VSOE is the primary method for determining the fair value of individual transaction prices in an arrangement.

To establish VSOE, companies must document the historical selling prices of each element and demonstrate a consistent pricing strategy for standalone sales.

Businesses should gather and maintain this evidence systematically to support accurate revenue recognition.

Proper documentation for VSOE includes sales invoices, price lists, and contracts that outline the terms and conditions for each element sold separately.

Third-Party Evidence (TPE)

If VSOE isn’t available, companies may consider TPE – source of evidence used to prove the existence and final amount of revenue earned by a contract.

TPE relies on the pricing data of comparable goods or services sold by other vendors in the market.

Companies should gather and maintain a comprehensive database of third-party pricing information, including:

• Competitor price lists
• Industry reports
• Market surveys
• Third-party expert opinions

International companies must also consider the impact of foreign currency exchange rates and local tax regulations when gathering third-party evidence.

Public Companies and Fair Values

Public companies have an additional responsibility to maintain accurate and transparent financial reporting.

In the absence of both VSOE and TPE, public companies can rely on a fair value estimation derived from an internally-developed methodology.

The fair value estimation should be based on market-based inputs and reliable estimates of expected cash flows.

This estimation can then be documented in the company’s financial records to prove the accuracy of revenue recognition.

The Importance of Revenue Recognition Software

Revenue recognition is a straightforward five-step process, but managing it across multiple contracts over the course of a fiscal year is cumbersome at best and overwhelming at worst.

According to the most recent IRS data, the average amount of unpaid taxes each year totals over $460 billion—a large amount of which is due to reporting errors.

These failed and inaccurate payments are ultimately collected, but carry additional fines and fees, as well as the cost of additional accounting resources for businesses.

Here are five ways businesses can benefit from revenue recognition software:

1. Automation saves companies time and resources. Revenue recognition automation makes the process of tracking and reporting revenue more accurate, efficient, and easier to manage.
2. Increased accuracy in financial reporting. Revenue recognition software enables businesses to take advantage of automated controls (such as data integrity checks) that can reduce the risk of errors or discrepancies in financial statements.
3. Detailed disclosure notes for stakeholders. The detailed records generated by revenue recognition software make it easier for businesses to provide accurate disclosure notes to stakeholders (investors, auditors, government regulators).
4. Integration with billing software. Deferred billing, performance obligations, and multiple-element arrangements are all components of the revenue recognition process that can be managed with automated billing software.
5. Compliance with new accounting standards. Revenue recognition software enables businesses to stay up-to-date with changing accounting regulations, such as ASC 606, and comply with new standards.

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