When allocating the transaction price for a contract with multiple performance obligations, what should the allocation be based on?

The correct approach for allocating the transaction price for a contract with multiple performance obligations is based on the stand-alone selling price of each obligation. This method ensures that the allocation reflects the value that each performance obligation represents when sold separately.

When a contract contains multiple performance obligations, it is essential to allocate the transaction price in a manner that reflects the individual value of those obligations. The stand-alone selling price is the price at which an entity would sell a promised good or service separately to a customer. By using the stand-alone selling prices, the allocation aligns with the relative value of each obligation within the context of the overall contract, leading to a fair and accurate representation of revenue on the financial statements.

This allocation method is crucial for accurately recognizing revenue in accordance with the principles of revenue recognition, as it reflects the business's pricing strategy and the economic reality of the transaction. It provides a basis that is not influenced by external factors such as market demand or overall contract value, ensuring that each performance obligation is represented fairly in the revenue recognized.