Revenue Recognition: Determine the Transaction Price

Land Owner should adjust the transaction price to include $100,000 of variable consideration for which it is probable a significant reversal of cumulative revenue recognized will not occur. Land Owner will update its estimate, either upward or downward, at each reporting date until the uncertainty is resolved. This example does not consider the potential need to constrain the estimate of variable consideration included in the transaction price. Depending on the facts and circumstances of each contract, a reporting entity might need to constrain its estimate of variable consideration even if it uses the expected value method to determine the transaction price. Refer to RR 4.3.2 for further discussion of application of the constraint on variable consideration. The transaction price includes such variable considerations, whether explicitly stated in the contract or implicitly stated.

• Using the most likely amount method, the total transaction price is $150,000.
• Management might be able to more easily conclude that variable consideration is not constrained when an uncertainty is resolved in a short period of time.
• ABC Company also pays XYZ Inc. a fee to ensure that its products receive prominent placement on store shelves (i.e., a slotting fee).
• Chemical Co will update its estimate of the total sales volume at each reporting date until the uncertainty is resolved.
• Variable consideration is defined broadly and can take many forms, such as incentives, penalty provisions, price concessions, rebates or refunds.
• The estimate is sensitive and can be impacted greatly by market volatility, weather conditions, legal and regulatory changes, internal factors, etc.

There are significant uncertainties related to achieving regulatory approval of the drug compound, which is subject to the judgments and actions of a third party. Biotech has concluded the milestone payments are outside the scope of guidance for financial instruments. The expected value—The expected value is the sum of probability-weighted amounts in a range of possible consideration amounts.

Allocation of variable consideration

Chemical Co will Variable Consideration its estimate of the total sales volume at each reporting date until the uncertainty is resolved. Chemical Co estimates that the total sales volume for the year will be 2.8 million containers based on its experience with similar contracts and forecasted sales to Municipality. Variable consideration is included in contracts with customers in a number of different forms.

The expected value approach also works well in situations where a spectrum of amounts is possible, as shown in Example A above. Terms that provide for cash payments to the customer for failure to comply with the terms of the contract or failure to meet agreed-upon specifications should generally be accounted for as variable consideration. These terms differ from a warranty provision that requires a vendor to repair or replace a product that does not function as expected. The transaction price is $90 per container based on Chemical Co’s estimate of total sales volume for the year, since the estimated cumulative sales volume of 2.8 million containers would result in a price per container of $90. The revenue standard also includes a narrow exception that applies only to licenses of intellectual property with consideration in the form of sales- and usage-based royalties. Revenue is recognized at the later of when the subsequent sale or usage occurs, or when the performance obligation to which some or all of the royalty has been allocated has been satisfied as discussed in RR 4.3.5.

Sales-based or usage-based royalties

A reporting entity might enter into a contract with stated terms that include a fixed price, but have a practice of subsequently providing price concessions or other price adjustments . A consistent practice of offering price concessions or other adjustments that are narrow in range might provide the predictive experience necessary to estimate the amount of consideration. A reporting entity that offers a broad range of concessions or adjustments might find it more difficult to predict the likelihood or magnitude of a revenue reversal. The objective of determining the transaction price is to predict the amount of consideration to which the reporting entity will be entitled, including amounts that are variable. Management determines the total transaction price, including an estimate of any variable consideration, at contract inception and reassesses this estimate at each reporting date.

For example, an SLA requiring a reporting entity to repair equipment to restore it to original specified production levels could be a warranty. SLAs that are not warranties and could result in payments to a customer are variable consideration. Price protection clauses, sometimes referred to as “most favored nation” clauses, allow a customer to obtain a refund if the seller lowers the product’s price to any other customers during a specified period. Price protection clauses ensure that the customer is not charged more by the seller than any other customer during this period.

Contingent consideration definition

It is appropriate for Contractor to use the most likely amount method to estimate the variable consideration. The contract’s transaction price is therefore $275 million, which includes the fixed contract price of $250 million and the $25 million award fee. In the construction industry, the transaction price is generally the contract price under the terms of the contract and may include fixed amounts, variable amounts or both. Determining the transaction price under the new standard requires contractors apply judgment and document processes and controls related to variable consideration, noncash consideration and the existence of a significant financing component. At the end of each reporting period, entities should update the estimated transaction price, including updating its assessment of whether an estimate of variable consideration is constrained (IFRS 15.59). Accounting for changes in the transaction price is covered in a separate section.

The transaction price should include management’s estimate of the amount of consideration to which the reporting entity will be entitled for the work performed. Contractor enters into a contract with Widget Inc to build an asset for $100,000 with a performance bonus of $50,000 that will be paid based on the timing of completion. The contract requirements are similar to contracts Contractor has performed previously, and management believes that such experience is predictive for this contract.

IAS 38 — Configuration or customisation costs in a cloud computing arrangement

Based on ABC Company’s experience, it is 95% likely that the contract will be completed by the specified date. ABC Company concludes that the most likely amount method is the most reliable method in this circumstance to determine the transaction price since only two possible outcomes are available. Using the most likely amount method, the total transaction price is $150,000.

• There are significant uncertainties related to achieving regulatory approval of the drug compound, which is subject to the judgments and actions of a third party.
• Estimates of variable consideration are subject to change as facts and circumstances evolve.
• Situations can arise where a reporting entity continues to perform under the terms of a contract with a customer that has expired while it negotiates an extension or renewal of that contract.
• As part of the total franchise fee, Frozen Delight also provides training (with a fair value of $2,000) to help franchisees get the store ready to open.
• However, revenue cannot be artificially inflated as discussed in the section on probability of receiving payment.

Companies are required to determine both the likelihood and the magnitude of potential reversals to correctly determine what amounts should be constrained. The constraint requires the most judgment when variable amounts are near the “probable” threshold. Contractor should update the transaction price based on its conclusion that it has an enforceable right to the claim. The claim amount is variable consideration and therefore, Contractor should include in the transaction price the estimated amount it will receive, adjusted for any amounts that are constrained under the variable consideration guidance. The transaction price at contract inception is $205,000, calculated as the fixed consideration of $200,000 plus the estimated minimum variable consideration of $5,000 that will be received for a 10% reduction in customer costs. Service Inc will update its estimate at each reporting date until the uncertainty is resolved.

A reporting entity that expects to provide a price concession, or has a practice of doing so, should reduce the transaction price to reflect the consideration to which it expects to be entitled after the concession is provided. Factors outside a reporting entity’s influence could also include the judgment or actions of third parties, including customers. An example is an arrangement where consideration varies based on the customer’s subsequent sales of a good or service. However, the reporting entity could have predictive information that enables it to conclude that variable consideration is not constrained in some scenarios. Management should use the method that it expects best predicts the amount of consideration to which the reporting entity will be entitled based on the terms of the contract. However, a single contract can include more than one form of variable consideration.