Company A needs to evaluate whether the volume purchase arrangement represents a material right.
Company A offers Company B a 33.3% discount ($4 discount off of the $12 per unit price, or $8 per unit) on all purchases after the first 1,000 units. They routinely offer other similar-sized customers a 5% discount on such purchases, resulting in a standalone selling price of $11.40 per unit. Therefore, the volume purchase arrangement represents a material right provided to Company B. Company A must calculate the value of the material right and allocate the total transaction price based on relative standalone selling prices. Alternatively, in this case, Company A meets the requirements to use the practical alternative in ASC 606-10-55-45.
Allocation based on relative standalone selling price
Company A needs to determine the standalone selling price of the option to purchase additional units at the discounted price. This is calculated as:
When Company A sells the first 1,000 units to Company B, it will receive $12,000 (1,000 units x $12). Company A would allocate $2,757 ($12,000 consideration x ($3,400/$14,800 total stand-alone selling price)) of the consideration to the material right (i.e., as a contract liability) and the remaining $9,243 would be recognized as revenue. The transaction price allocated to the material right, based on the relative standalone selling price, will be recognized upon exercise (that is, purchase of additional product) or expiry.
When Company A sells the second 1,000 units to Company B, it will receive $8,000 (1,000 units x $8). Company A would recognize the $8,000 received as well as the $2,757 allocated to the material right. By purchasing the second 1,000 units, Company B has fully exercised its option to purchase products at the discounted price since Company A does not expect Company B to purchase any additional units under the contract. Accordingly, the full value allocated to the material right should be recognized.
In this case, Company A would report $9,243 of revenue associated with the first 1,000 units of product and $10,757 ($8,000 plus $2,757) related to the second 1,000 units.
Practical alternative (ASC 606-10-55-45)
Since it has a sufficient basis to estimate that 2,000 units will be purchased, Company A could estimate the total consideration that Company B will pay under the volume purchase arrangement and allocate it to the expected total purchase of 2,000 units. The transaction price per unit on 2,000 units would be $10 ((1,000 units x $12 plus 1,000 units x $8)/2,000 total units). As each unit is shipped, Company would recognize revenue of $10. At the end of each quarter, it would revise the estimate of sales under the volume purchase arrangement and record a true-up to reflect the cumulative adjustment on shipments through that date.
As demonstrated above, the practical alternative will often result in a different allocation of revenue than allocating revenue on a relative selling price basis between the initial units and the option.