Chapter 6 — Step 3: Determine the Transaction Price

6.1 Overview

The FASB and IASB decided, as described further in paragraph BC181 of ASU 2014-09, that revenue should be measured on the basis of an allocated transaction price.

As noted in paragraph BC183 of ASU 2014-09, the allocated transaction price approach under the revenue standard generally requires an entity to proceed in three main phases. The first of these phases, determining the transaction price, is the pillar of that measurement approach. The transaction price determined in the first phase will be allocated in step 4 to the performance obligations identified in step 2 (phase 2) for recognition in step 5 (phase 3). ASC 606-10-32-2 provides the following guidance on determining the transaction price:

ASC 606-10

32-2 An entity shall consider the terms of the contract and its customary business practices to determine the transaction price. The transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties (for example, some sales taxes). The consideration promised in a contract with a customer may include fixed amounts, variable amounts, or both.

Connecting the Dots

Inherent in ASC 606-10-32-2 is that an entity’s determination of the transaction price is a measurement at the contract level, as opposed to a lower level (an individual performance obligation) or a higher level (an overall customer relationship). The revenue standard’s allocation objective is to allocate the transaction price to each performance obligation. Accordingly, the transaction price must be determined in step 3 at the contract level before it can be allocated to the distinct units of account at a lower level (i.e., the performance obligations) in step 4.

The revenue standard establishes the “transaction price” as an amount to which the entity expects to be entitled to under the contract. That is, it is an expected amount, and so inherently, estimates are required. The boards intentionally used the wording “be entitled” rather than “receive” or “collect” to distinguish collectibility risk from other uncertainties that may occur under the contract (see Section 4.3.5 for further discussion of where collectibility risk falls in the standard’s revenue model). The uncertainties that are measured as part of the transaction price are further discussed in the next sections.

6.1.1 Components of the Transaction Price

ASC 606-10

32-3 The nature, timing, and amount of consideration promised by a customer affect the estimate of the transaction price. When determining the transaction price, an entity shall consider the effects of all of the following:

Variable consideration (see paragraphs 606-10-32-5 through 32-10 and 606-10-32-14)
Constraining estimates of variable consideration (see paragraphs 606-10-32-11 through 32-13)
The existence of a significant financing component in the contract (see paragraphs 606-10-32-15 through 32-20)
Noncash consideration (see paragraphs 606-10-32-21 through 32-24)
Consideration payable to a customer (see paragraphs 606-10-32-25 through 32-27).

32-4 For the purpose of determining the transaction price, an entity shall assume that the goods or services will be transferred to the customer as promised in accordance with the existing contract and that the contract will not be cancelled, renewed, or modified.

Paragraph BC185 of ASU 2014-09 states that the FASB and IASB defined “transaction price” in such a manner as to require an entity, at the end of each reporting period, “to predict the total amount of consideration to which the entity will be entitled from the contract” with the customer. In meeting this objective, an entity should evaluate those elements that affect the nature, timing, and uncertainty of cash flows related to its revenues and reflect such elements in its measurement of revenue.

In paragraph BC188 of ASU 2014-09, the boards acknowledge that determining the transaction price in a contract that contains only fixed or known cash flows will be simple. However, because of the nature of certain pricing features and cash flow structures, determining the amount to which an entity will be entitled will be inherently complex in many contracts. In light of this, the boards also acknowledge that determining the transaction price in step 3 will be more difficult when contracts with customers contain:

Consideration that is variable until the resolution of future uncertainties (i.e., variable consideration).
Financing components that are significant to the contract’s overall cash flow stream and pricing (i.e., significant financing components).
Consideration in a form other than cash (i.e., noncash consideration).
Consideration that is payable by the entity to its customer (i.e., consideration payable to a customer).

Further, paragraph BC187 of ASU 2014-09 notes that it may be more difficult to determine the transaction price when amounts to which an entity is entitled are sourced from parties other than a customer (e.g., a manufacturer’s payments to a retailer as a result of a customer’s use of a manufacturer’s coupon at the retailer’s store). The boards clarified that such amounts are included in an entity’s determination of the transaction price.

However, because the boards established the transaction price as an amount to which the entity expects to be entitled (and not an amount that the entity expects to collect), the transaction price by design generally excludes one measurement component that is common in other aspects of accounting — namely, credit risk (see Section 6.1.2).

6.1.2 Effect of a Customer’s Credit Risk on the Determination of the Transaction Price

When measuring the transaction price, an entity should take a customer’s credit risk into account only to determine (1) the discount rate used to adjust the promised consideration for a significant financing component, if any, and (2) potential price concessions.

ASC 606-10-32-2 specifies that the transaction price is the amount to which an entity expects to be entitled rather than the amount it expects to collect. The determination of the amount to which an entity expects to be entitled is not affected by the risk of whether it expects the customer to default (i.e., the customer’s credit risk) unless a price concession is expected. Paragraphs BC260 and BC261 of ASU 2014-09 explain that this approach was adopted to enable users of the financial statements to analyze “gross” revenue (i.e., the amount to which the entity is entitled) separately from the effect of receivables management (or bad debts).

However, when the timing of payments due under the contract provides the customer with a significant benefit of financing, the transaction price is adjusted to reflect the time value of money. Paragraph BC239 of ASU 2014-09 indicates that in such circumstances, an entity will take a customer’s credit risk into account in determining the appropriate discount rate to apply. As illustrated in Section 6.4.5, this rate will affect the amount of revenue recognized for the transfer of goods or services under the contract.

Further, a customer’s credit risk is also a factor in the determination of whether a contract exists, because one of the criteria for identification of a contract in ASC 606-10-25-1 is that collection of substantially all of the consideration to which the entity is entitled is probable (specifically, ASC 606-10-25-1(e)). See Section 4.3.5 for further discussion of how a customer’s credit risk affects an entity’s identification of its contract with the customer in step 1.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.