Once you have the contract in the system, then you turn it into a revenue agreement. This is where fair value might come into play depending on the situation. Similar to defining a contract, you will need to discuss this with your auditors or put an accounting lens on to determine if each line on the contract is what you bill the customer. If it is always the fair value that you sell to all customers then you wouldn’t need to reallocate, as the amount billed the customer is always the same thing as a fair value.
In other situations, there may be a wider variance between how you sell each performance obligation to a customer and what is billed on the contract, or the invoice doesn’t reflect the fair value. In this case, you would do a fair value allocation and determine the relative selling price for each item based on the analysis of historical transactions or market prices or a price list – whichever method you think is most appropriate. Each item will then have a relative performance obligation, meaning it will have its own estimated selling price or relative selling price.
Below is a short demo of how you can turn a contract into a revenue agreement in Tensoft Revenue Lens.
Full Transcript of the Video:
“This is the screen where most of the turning it into a revenue agreement happens on the item. Each item would be considered a performance obligation and then you would have revenue rules and this is a requirement. So every item will have a revenue rule, which basically says over what time period is it, at a default, amortized over, either straight line or a milestone or percent complete. If it’s straight line, over what time period. You can even split up an item to have multiple revenue rules – split it out certain percentage wise between different types of revenue recognition.
So every item would have a revenue rule and if it’s not being fair value allocated, you wouldn’t need to add fair value. But if you are doing fair value allocation, you would have to say what is your range of selling price for that particular item. So when the agreement comes in, you would take that total value for whatever you say the contract is and then allocate it amongst each item or performance obligation on that revenue agreement based on each item’s relative selling price. So it’s a percentage. You would basically take each fair value for each item and total it and say here’s the percent of each item. The total adds to 100 and you use those percentages to allocate the total contract value to each performance obligation. So that’s how you would turn it into a revenue agreement.
At this point, you’ve got one or many invoices combined to create a revenue agreement. You split that out based on the relative selling price of each item and then those values that were allocated to each item will then be amortized over a certain period of time based on the revenue rules for that item.”
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