6.3 Variable Consideration
ASC 606-10
32-6 An amount of consideration can vary because of discounts, rebates, refunds, credits, price concessions,
incentives, performance bonuses, penalties, or other similar items. The promised consideration also can vary
if an entity’s entitlement to the consideration is contingent on the occurrence or nonoccurrence of a future
event. For example, an amount of consideration would be variable if either a product was sold with a right of
return or a fixed amount is promised as a performance bonus on achievement of a specified milestone.
32-7 The variability relating to the consideration promised by a customer may be explicitly stated in the
contract. In addition to the terms of the contract, the promised consideration is variable if either of the
following circumstances exists:
- The customer has a valid expectation arising from an entity’s customary business practices, published policies, or specific statements that the entity will accept an amount of consideration that is less than the price stated in the contract. That is, it is expected that the entity will offer a price concession. Depending on the jurisdiction, industry, or customer this offer may be referred to as a discount, rebate, refund, or credit.
- Other facts and circumstances indicate that the entity’s intention, when entering into the contract with the customer, is to offer a price concession to the customer.
As noted above, ASC 606 creates a single framework under which an
entity assesses variable consideration in a contract with a customer to determine
the amount to include in its transaction price. The decision tree below illustrates
the application of that framework.
6.3.1 Identifying Variable Consideration
As the FASB and IASB acknowledge in paragraph BC190 of ASU 2014-09, consideration in a contract
with a customer may vary as a result of many different factors, and variability may arise in many different
circumstances. Variable consideration is easiest to identify in a contract when price (P) or quantity (Q), or
both, are not fixed and known at the contract’s inception.
For example, an entity may enter into a contract with a customer to sell 1,000 barrels of crude oil every
month for 12 months at the prevailing market index price for the contract’s delivery location. The entity
determines that (1) the contract meets the criteria in ASC 606-10-25-1 to be accounted for as a contract
with a customer and (2) each barrel of oil delivered is a distinct performance obligation in accordance
with ASC 606-10-25-14(a). In this arrangement, Q is fixed, but P varies on the basis of changes in the
market price of oil. As a result, the total transaction price calculation of P × Q is variable.
The identification of variable consideration may become more complicated when only part of P or Q,
or both, is not fixed and known at the contract’s inception. Assume the facts of the preceding example,
except that the price of each barrel of crude oil is the prevailing market index price plus $5. Now, part
of the transaction price is fixed because regardless of the market price of oil, the entity will receive
consideration of at least P × Q = $5 × (1,000 × 12) = $60,000.
The boards acknowledge in paragraphs BC190 through BC194 of ASU 2014-09 that consideration in a
contract may vary as a result of unresolved contingencies (i.e., variability in transaction price inputs other
than P or Q). In these instances, the occurrence or nonoccurrence of a future event would trigger a
cash flow stream in the contract. Such contingency-based variability may be explicit in a contract (e.g., a
contract providing for a sale with a right of return, as noted in paragraph BC191).
Example 20 in ASC 606 illustrates a performance penalty (bonus) as a form of explicit contingency-based
variable consideration.
ASC 606-10
Example 20 — Penalty Gives Rise to Variable Consideration
55-194 An entity enters into a contract with a customer to build an asset for $1 million. In addition, the terms
of the contract include a penalty of $100,000 if the construction is not completed within 3 months of a date
specified in the contract.
55-195 The entity concludes that the consideration promised in the contract includes a fixed amount of
$900,000 and a variable amount of $100,000 (arising from the penalty).
55-196 The entity estimates the variable consideration in accordance with paragraphs 606-10-32-5 through
32-9 and considers the guidance in paragraphs 606-10-32-11 through 32-13 on constraining estimates of
variable consideration.
The boards also note in paragraph BC192 of ASU 2014-09 that they decided to
include in the determination of the transaction price consideration that is
implicitly variable in the arrangement. The consideration to which an entity is
ultimately entitled may be less than the price stated in the contract because
the customer may be offered, or expects, a price concession. This creates
variability in the amount to which an entity expects to be entitled and is thus
a form of variable consideration even though there is no explicitly stated price
concession in the contractual terms. Accordingly, an entity should consider all
facts and circumstances in a contract with a customer to determine whether it
would accept an amount that is lower than the consideration stated in the
contract. If so, the total transaction price is variable because it is
contingent on the occurrence or nonoccurrence of an event (i.e., the entity’s
grant of an implicit price concession to the customer).
Entities will need to use significant judgment in determining whether they have
provided an implicit price concession (i.e., whether they have the expectation
of accepting less than the contractual amount of consideration in exchange for
goods or services) or have accepted a customer’s credit risk (i.e., whether they
have accepted the risk of collecting less consideration than what they
legitimately expected to collect from the customer). Credit risk, as noted in
Section 6.1.2,
is generally not measured as part of the transaction price (except in the
determination of the discount rate an entity should use when adjusting the
transaction price for a significant financing component [see Section 6.4.4] or in the
determination of potential concessions associated with credit risk [see
Section 6.1.2]) but is addressed in
step 1 of the revenue model as part of the gating analysis of whether revenue
from a contract with a customer should be recognized in accordance with ASC 606.
Further, Section
4.3.5.2 discusses indicators of when the variability between the
contractually stated price and the amount the entity expects to collect is due
to a price concession.
In addition to the forms of variability already discussed, the following are common features in contracts
with customers that also may be more difficult to identify as variable consideration but nevertheless
drive variability in contract consideration:
- Royalty arrangements (further discussed in Section 6.3.5.1).
- Product returns and other customer credits (further discussed in Sections 6.3.5.2 and 6.3.5.3).
- Variable quantities and volumetric optionality (further discussed in Section 6.3.5.4).
- Rebates (volume-based rebates are further discussed in Section 6.3.5.4.2).
- Discounts (cash discounts are further discussed in Section 6.3.5.5.3; and volume discounts are discussed in Example 24 from ASC 606, which is included in Section 6.3.5.4.2).
- Performance-based bonuses or penalties (further discussed in the context of bonuses in Section 6.3.2.1; and also further discussed in the context of both bonuses and penalties and in Example 21 of ASC 606, which is included in Section 6.3.2.3).
6.3.2 Estimating Variable Consideration
Regardless of the form of variability or its complexity, once variable consideration is identified, an entity
must estimate the amount of variable consideration to determine the transaction price in a contract
with a customer.
ASC 606-10
32-5 If the consideration
promised in a contract includes a variable amount, an
entity shall estimate the amount of consideration to
which the entity will be entitled in exchange for
transferring the promised goods or services to a
customer.
32-8 An entity shall estimate an amount of variable consideration by using either of the following methods,
depending on which method the entity expects to better predict the amount of consideration to which it will be
entitled:
- The expected value — The expected value is the sum of probability-weighted amounts in a range of possible consideration amounts. An expected value may be an appropriate estimate of the amount of variable consideration if an entity has a large number of contracts with similar characteristics.
- The most likely amount — The most likely amount is the single most likely amount in a range of possible consideration amounts (that is, the single most likely outcome of the contract). The most likely amount may be an appropriate estimate of the amount of variable consideration if the contract has only two possible outcomes (for example, an entity either achieves a performance bonus or does not).
32-9 An entity shall apply
one method consistently throughout the contract when
estimating the effect of an uncertainty on an amount of
variable consideration to which the entity will be
entitled. In addition, an entity shall consider all the
information (historical, current, and forecast) that is
reasonably available to the entity and shall identify a
reasonable number of possible consideration amounts. The
information that an entity uses to estimate the amount
of variable consideration typically would be similar to
the information that the entity’s management uses during
the bid-and-proposal process and in establishing prices
for promised goods or services.
Paragraph BC199 of ASU 2014-09 notes that when the FASB and IASB deliberated the
guidance to be included in the revenue standard, they “observed that users of
financial statements are most interested in knowing the total amount of
consideration that ultimately will be realized from the contract.” The boards
decided that the most decision-useful information about the transaction price in
a contract with a customer is an estimate that will better predict the amount of
consideration to which the entity will be entitled. The concept of transaction
price (i.e., the amount to which the entity expects to be entitled) differs from
that of fair value. The transaction price is a contract-specific measurement
that is determined on the basis of the entity’s estimation process (which
inherently incorporates historical practice and forward expectations), whereas
fair value is a market-based measurement.
Initially, the boards decided that a probability-weighted model of measuring the
transaction price at its expected value best allowed entities to predict the
amount of consideration to which they will ultimately be entitled. In the
boards’ 2010 exposure draft on revenue (issued by the FASB as a proposed ASU), the boards proposed requiring a single
estimation technique of expected value. However, in light of feedback on the
practical challenges of such an approach, the boards were sympathetic to
stakeholders’ concerns about fact patterns with, for example, an “all or
nothing” performance bonus (in which the entity would either receive the entire
performance bonus or nothing). Specifically, as noted in paragraph BC200 of ASU
2014-09, the boards acknowledged that in a contract with variable consideration
that could result in only one of two outcomes upon the occurrence of a binary
event (such as in the “all or nothing” performance bonus fact patterns), an
expected value calculated through probability weighting would not be one of
those two possible outcomes and thus would not be a decision-useful estimate.
Consequently, the boards decided that both an expected value method and a most
likely amount method are acceptable for an entity to consider when selecting the
most appropriate method of estimating variable consideration within the
parameters of the objective in ASC 606-10-32-8 (see Section 6.3.2.1 for further discussion of
selecting the most appropriate method).
Connecting the Dots
As stated in the first sentence of ASC 606-10-32-9, a single method of estimating variable
consideration should be used throughout the term of the contract with the customer. That is,
the method of estimating variable consideration should not be reassessed or changed once it is
selected as the most appropriate.
In paragraph BC197 of ASU 2014-09, the boards briefly discuss “management’s best estimate”
as a method of estimating variable consideration and acknowledge stakeholders who noted in
deliberations that such a method “would provide management with the flexibility to estimate
on the basis of its experience and available information without the documentation that would
be required when a measurement model is specified.” However, as noted in paragraph BC201
of ASU 2014-09, the boards do not anticipate that either the most likely amount method or the
expected value method of estimating variable consideration will be too costly or complex for
entities to apply to contracts with customers. Specifically, the boards allow that an entity would
not be expected to develop complex modeling techniques to identify all possible outcomes of
variable consideration when determining the most likely outcome or a probability distribution of
outcomes. Thus, the benefits of applying the most likely amount method or the expected value
method to estimate variable consideration exceed the costs of doing so.
Although we think that it is appropriate for an entity
to be pragmatic in deriving an estimate by using either the most likely
amount method or the expected value method as required, we do not
think that it is appropriate to use a method described as management’s
best estimate as either the most likely amount or the expected value of
variable consideration.
6.3.2.1 Selection of Method Used to Estimate Variable Consideration
When determining the appropriate method for estimating
variable consideration, an entity should choose whichever method will better
predict the amount of consideration to which it will become entitled. When a
contract has only two possible outcomes, it will often be appropriate to
estimate variable consideration by using a method based on the most likely
amount. When the entity has a large number of contracts with similar
characteristics and the outcome for each contract is independent of the
others, the expected value method may better predict the overall outcome for
the contracts in the aggregate. This will be true even when each individual
contract has only two possible outcomes (e.g., a sale with a right of
return). This is because an entity will often have better information about
the probabilities of various outcomes when there are a large number of
similar transactions.
It is important, however, to consider carefully whether the
outcome for each contract is truly independent of the others. For example,
if the outcome is binary but is determined by the occurrence or
nonoccurrence of the same event for all contracts (i.e., the variable amount
will be received either for all of the contracts or for none of them), the
expected value is unlikely to be a good predictor of the overall outcome and
the entity may need to use the most likely amount method to estimate the
variable consideration in the contracts.
Example 6-1
Each year, Entity X’s performance is
ranked against that of its competitors in a
particular jurisdiction. All of X’s customer
contracts specify that a fixed bonus of $500 will be
due to X if it is ranked in the top quartile. Entity
X has approximately 1,000 customer contracts.
Entity X should estimate the
variable consideration (i.e., the bonus) on the
basis of the most likely amount. Although X has a
large number of similar contracts, the outcomes are
not independent because they all depend on the same
criterion (i.e., the ranking of X against its
competitors). The bonus will be payable under either
all the contracts or none of them. Thus, the overall
outcome for the contracts in the aggregate will be
binary and the expected value will not be a good
predictor of that overall outcome.
6.3.2.2 Using a Portfolio of Data Versus the Portfolio Practical Expedient When Applying the Expected Value Method
When an entity applies the expected value method, it may consider evidence
(i.e., a portfolio of data) from other similar contracts to form its
estimate of expected value. Stakeholders raised questions about whether the
evaluation of a portfolio of data from other similar contracts in estimating
an expected value of variable consideration would mean that an entity is
applying the “portfolio practical expedient” discussed in Section 3.1.2.2. The concern was exacerbated
by the follow-on question of whether an entity using a portfolio of data to
estimate an expected value would also need to meet the necessary condition
of the portfolio practical expedient that the results of doing so may not
differ materially from the results of applying the guidance to the contracts
individually.
The example below clarifies that an entity’s use of a
portfolio of data from other similar contracts to calculate an estimate of
the expected value of variable consideration is not the same as using
the portfolio practical expedient.
Example 6-2
Entity B enters into a contract to
sell Product X to Customer C for $50. Entity B’s
policy allows unused products to be returned within
30 days for a refund. Therefore, the contract
includes variable consideration. In addition to the
transaction with C, B has a large number of similar
sales of Product X (i.e., a homogeneous population
of contracts) with the same right of return
provision.
There are two methods for estimating
variable consideration under ASC 606: (1) the
expected value method and (2) the most likely amount
method. See Section 6.3.2.1
for guidance on factors to be considered in the
selection of the most appropriate method in
particular circumstances.
Under the expected value method, B
considers a portfolio of historical data that
includes contracts for Product X. Entity B concludes
that this portfolio of historical data is relevant
and consistent with the characteristics of the
contract with C. The portfolio of data indicates
that 10 out of every 100 products were returned.
Using this portfolio of data, B estimates the
expected value to be $45, or $50 – ($50 × 10%), for
the sale of Product X to C. That is, when a
portfolio of data is used to estimate variable
consideration under the expected value method, the
amount estimated may not represent a possible
outcome of an individual contract.
If B were to apply the most likely
amount method, it would consider the two possible
outcomes for this contract (i.e., $0 and $50) and
estimate the variable consideration to be $50.
In accordance with ASC 606-10-32-8,
B should estimate variable consideration by using
whichever method will better predict the amount of
consideration to which it will become entitled. When
selecting which method to use to estimate variable
consideration in accordance with ASC 606-10-32-8, B
concludes that the expected value method will better
predict the amount of consideration to which it will
become entitled (see Section
6.3.2.1). That is, an estimate of $45 is
likely to be consistent with the ultimate resolution
of the uncertainty related to the product return
right in these circumstances. This is because when
there are a large number of similar transactions
(i.e., a homogeneous population of contracts), the
entity’s expectation of the amount of consideration
to which it will be entitled is better predicted by
reference to the probabilities of outcomes exhibited
by that portfolio of similar data. By using a
portfolio of data to make an estimate of variable
consideration, an entity considers evidence from
other, similar contracts to form an estimate of
expected value.
It is important to highlight that in
this example, B is not applying the portfolio
practical expedient.2 An entity’s election to use a portfolio of
contracts to make estimates and judgments about
variable consideration (including evaluating the
constraint) for a specific contract is not the same
as using the portfolio approach as a practical
expedient. Therefore, the restriction on using the
portfolio practical expedient (i.e., the entity does
not expect the results of applying ASC 606 to a
portfolio of contracts with similar characteristics
to be materially different from the results of
applying the guidance to the individual contracts in
the portfolio) does not apply.
The above issue is addressed in Q&A 39 (compiled from
previously issued TRG Agenda Papers 38 and 44) of the FASB staff’s Revenue Recognition Implementation Q&As
(the “Implementation Q&As”). For additional information and Deloitte’s
summary of issues discussed in the Implementation Q&As, see Appendix C.
6.3.2.3 Using More Than One Method to Estimate Variable Consideration Within One Contract
When a contract contains multiple elements of variability, an entity can use
more than one method (i.e., the expected value method and the most likely
amount method) to estimate the amount of variable consideration to include
in the transaction price. Example 21 in ASC 606-10-55-197 through 55-200
(reproduced below) shows that an entity should prepare a separate estimate
for each element of variable consideration in a contract (i.e., for each
uncertainty) by using either the expected value method or the most likely
amount method, whichever method better predicts the amount of consideration
to which it will be entitled.
ASC 606-10
Example 21 — Estimating Variable
Consideration
55-197 An entity enters into
a contract with a customer to build a customized
asset. The promise to transfer the asset is a
performance obligation that is satisfied over time.
The promised consideration is $2.5 million, but that
amount will be reduced or increased depending on the
timing of completion of the asset. Specifically, for
each day after March 31, 20X7 that the asset is
incomplete, the promised consideration is reduced by
$10,000. For each day before March 31, 20X7 that the
asset is complete, the promised consideration
increases by $10,000.
55-198 In addition, upon
completion of the asset, a third party will inspect
the asset and assign a rating based on metrics that
are defined in the contract. If the asset receives a
specified rating, the entity will be entitled to an
incentive bonus of $150,000.
55-199 In determining the
transaction price, the entity prepares a separate
estimate for each element of variable consideration
to which the entity will be entitled using the
estimation methods described in paragraph
606-10-32-8:
-
The entity decides to use the expected value method to estimate the variable consideration associated with the daily penalty or incentive (that is, $2.5 million, plus or minus $10,000 per day). This is because it is the method that the entity expects to better predict the amount of consideration to which it will be entitled.
-
The entity decides to use the most likely amount to estimate the variable consideration associated with the incentive bonus. This is because there are only 2 possible outcomes ($150,000 or $0) and it is the method that the entity expects to better predict the amount of consideration to which it will be entitled.
55-200 The entity considers
the guidance in paragraphs 606-10-32-11 through
32-13 on constraining estimates of variable
consideration to determine whether the entity should
include some or all of its estimate of variable
consideration in the transaction price.
Because ASC 606-10-32-9 requires entities to apply one method consistently to
each variable element throughout the contract, it would not be appropriate
to switch between the most likely amount and expected value method for a
particular variable element during the life of a contract.
An entity should also consider the guidance in ASC 606-10-32-11 through 32-13
on constraining estimates of variable consideration to determine whether it
should include some or all of the variable consideration in the transaction
price.
Example 6-3
Entity X, an IT service provider, enters into a
unique contract with a customer to develop the
customer’s Web site. To induce X to complete the
project on a timely basis and to provide a solution
that drives business growth for the customer, the
fee receivable by X under the contract includes
variable consideration that is determined as follows:
-
One element of the fee is based on the performance of the Web site and is determined by using a sliding scale from $500,000 to $1 million. The amount earned is based on a formula that uses a number of metrics (e.g., the number of pages viewed and the number of unique visitors) measured over the two-year period after the Web site is completed and fully functional.
-
The other element of the fee is based on the timely completion of the Web site and is determined as follows:
-
$1 million if the Web site is completed and fully functional within 90 days of the signing of the contract.
-
$500,000 if the Web site is completed and fully functional more than 90 days after the contract is signed.
-
Having considered the guidance in ASC 606-10-32-8 on
selecting an appropriate method for estimating the
amount of variable consideration, X applies the
following methods to each element of variability in
the contract:
-
The amount of consideration related to the performance of the customer’s Web site is estimated by using the expected value method because X estimates that it could be entitled to a wide range of possible consideration amounts (any amount between $500,000 and $1 million).
-
The amount of consideration related to the timely completion of the Web site is estimated by using the most likely amount method because this element of variable consideration has only two possible outcomes ($1 million if the Web site is completed and fully functional within 90 days or $500,000 if it is completed and fully functional after more than 90 days). Since the contract is unique, X does not have a pool of similar contracts from which to develop a portfolio of data it would need to use the expected value method.
Entity X should continue to use the selected method
for each element consistently for the entire
duration of the contract.
It is important to note the distinction between an element
of variable consideration and a performance obligation. The former concept
refers to a unique, incremental driver of variability or uncertainty in the
transaction price, while the latter concept refers to a unit of account
identified in step 2 (see Chapter 5). This distinction is intended to clarify that an
estimate of variable consideration is performed for each incremental driver
of variability at the contract level and not at the performance
obligation level. A total transaction price for the contract, including any
estimates of variable consideration, must be determined in step 3 before it
can be allocated in step 4 to the performance obligations identified in step
2 (unless the invoice practical expedient for measuring progress toward
complete satisfaction of a performance obligation [see Section 8.5.8.1] or
the variable consideration exception under ASC 606-10-32-40 [see Section 7.5] is
applied).
6.3.3 Constraining Estimates of Variable Consideration
Since revenue is one of the most important metrics to users of financial
statements, the boards and their constituents agreed that estimates of variable
consideration are only useful to the extent that an entity is confident that the
revenue recognized as a result of those estimates will not be subsequently
reversed. Accordingly, as noted in paragraph BC203 of ASU 2014-09, the boards
acknowledged that some estimates of variable consideration should not be
included in the transaction price if the inherent uncertainty could prevent a
faithful depiction of the consideration to which the entity expects to be
entitled in exchange for delivering goods or services. Thus, the focus of the
boards’ deliberations on a mechanism to improve the usefulness of estimates in
revenue as a predictor of future performance was to limit subsequent downward
adjustments in revenue (i.e., reversals of revenue recognized). The result of
those deliberations is what is commonly referred to as the “constraint.”
The constraint is thus a biased estimate that focuses on possible future downward revenue adjustments
(i.e., revenue reversals) rather than on all revenue adjustments (i.e., both upward or favorable
adjustments and downward or unfavorable adjustments). In paragraph BC207 of ASU 2014-09, the
boards acknowledge that the constraint requirement “creates a tension with the notion of neutrality in
the Boards’ respective conceptual frameworks” because of the downward bias in estimation. However,
the boards ultimately accepted this bias in favor of user feedback, which placed primacy on the
relevance of the estimate; and in the context of revenue, the preference was for the estimate not to be
subject to significant future reversals.
ASC 606-10
32-11 An entity shall include
in the transaction price some or all of an amount of
variable consideration estimated in accordance with
paragraph 606-10-32-8 only to the extent that it is
probable that a significant reversal in the amount of
cumulative revenue recognized will not occur when the
uncertainty associated with the variable consideration
is subsequently resolved.
Inherent in the language of ASC 606-10-32-11 is a link between the measurement of variable
consideration in the transaction price (step 3) and the recognition of an appropriate amount of revenue
(step 5; see Chapter 8). That is, the constraint is naturally a measurement concept because it influences
the amount of variable consideration included in the transaction price. However, its application is driven
by a recognition concept and the avoidance of reversing the cumulative amount of revenue previously
recognized.
During the development of the constraint guidance, its placement was debated since, as discussed in
paragraph BC221 of ASU 2014-09, the boards concluded that the constraint includes concepts from
both step 3 (measurement) and step 5 (recognition). Ultimately, the boards included the constraint in
the measurement guidance of step 3, but the constraint guidance’s wording of the phrase “a significant
reversal in the amount of cumulative revenue recognized will not occur” draws on recognition concepts.
As explained in paragraph BC221, the boards observed that constraining the transaction price and limiting the cumulative amount of revenue recognized “are not truly independent objectives because
the measurement of revenue determines the amount of revenue recognized. In other words, the
guidance for constraining estimates of variable consideration restricts revenue recognition and uses
measurement uncertainty as the basis for determining if (or how much) revenue should be recognized.”
ASC 606-10
32-12 In assessing whether it is probable that a significant reversal in the amount of cumulative revenue
recognized will not occur once the uncertainty related to the variable consideration is subsequently resolved,
an entity shall consider both the likelihood and the magnitude of the revenue reversal. Factors that could
increase the likelihood or the magnitude of a revenue reversal include, but are not limited to, any of the
following:
- The amount of consideration is highly susceptible to factors outside the entity’s influence. Those factors may include volatility in a market, the judgment or actions of third parties, weather conditions, and a high risk of obsolescence of the promised good or service.
- The uncertainty about the amount of consideration is not expected to be resolved for a long period of time.
- The entity’s experience (or other evidence) with similar types of contracts is limited, or that experience (or other evidence) has limited predictive value.
- The entity has a practice of either offering a broad range of price concessions or changing the payment terms and conditions of similar contracts in similar circumstances.
- The contract has a large number and broad range of possible consideration amounts.
Inherent in ASC 606-10-32-12 are three key aspects of the assessment necessary to determine whether
an estimate of variable consideration in a contract with a customer should be constrained in an entity’s
transaction price:
- The likelihood of a reversal in the cumulative amount of revenue recognized (i.e., a qualitative aspect).
- The magnitude (or significance) of the potential reversal in the cumulative amount of revenue recognized (i.e., a quantitative aspect).
- The threshold that triggers a constrained estimate (i.e., the use of “probable”).
In paragraph BC214 of ASU 2014-09, the boards acknowledge that the application
of the constraint was designed to be part of a two-step process: (1) estimate
variable consideration (see Section 6.3.2) and then (2) assess whether it is probable that a
significant reversal in the amount of revenue recognized from that estimate of
variable consideration will occur once the underlying uncertainty is resolved.
However, the boards go on to explain in paragraph BC215 that an entity is not
required to perform a two-step process if the entity “already incorporates the
principles on which the guidance for constraining estimates of variable
consideration is based.” The boards recognized that an entity may incorporate
into its existing estimation processes today the qualitative principles inherent
in applying the constraint. This notion is illustrated by the boards’ use of the
indicators in ASC 606-10-32-12, which were derived from legacy, qualitative
revenue guidance related to sales returns.
Further, in paragraph BC212 of ASU 2014-09, the boards address stakeholder
concerns raised during the deliberations on the ASU that the application of the
constraint would require a significantly quantitative process. The boards
expressly acknowledge in their cost-benefit analysis of the standard’s revenue
guidance that a quantitative process is not always required, and a qualitative
analysis is expected to be sufficient for applying the constraint guidance in
many cases.
The term “probable” in ASC 606-10-32-11 is intended to mean that “the future
event or events are likely to occur,” which is consistent with the definition in
ASC 450. Paragraph 56 of IFRS 15, the IFRS counterpart of ASC 606-10-32-11, uses
the term “highly probable” rather than “probable.” Since “probable” is defined
in IFRS 5 as “more likely than not,” paragraph 56 of IFRS 15 uses “highly
probable” to achieve the same meaning as “probable” in ASC 606-10-32-11.
Therefore, despite the difference in wording, there is no difference between the
intended meaning of ASC 606-10-32-11 and that of paragraph 56 of IFRS 15. For a
list of differences between U.S. GAAP and IFRS Accounting Standards regarding
revenue-related issues on which the boards could not converge, see Appendix A.
Connecting the Dots
Although the guidance on constraining estimates of variable consideration is intended to
avoid significant downward adjustments in revenue after it has been recognized, we generally
do not think that it would be appropriate to constrain 100 percent of an estimate of variable
consideration. That is, we do not think that the factors in ASC 606-10-32-12 could be so
significant that an estimate of variable consideration should be entirely constrained from
the transaction price. This concept is different from a $0 estimate of variable consideration.
A 100 percent constraint on an estimate of variable consideration that is not $0, however,
would generally go against the measurement principle of ASC 606, which is to include in the
transaction price the amount to which an entity expects to be entitled for its performance so
that the entity can provide financial statement users a better prediction of future revenues.
While the above is a general interpretation, there are exceptions in the revenue
standard that may allow for a 100 percent constraint on an estimate of
variable consideration. Example 25 in ASC 606-10-55 discusses an
exception in which market-based factors are a significant driver of
variability in the transaction price. Also, in paragraph BC415 of ASU
2014-09, the boards discuss their rationale for providing an exception
for sales- or usage-based royalties in a license of intellectual
property (IP). See Section
6.3.5.1 and Chapter 12 for further discussion of sales- or usage-based
royalties. Outside of these exceptions, an entity should include a
minimum amount of variable consideration in the transaction price if
management believes that this minimum amount is not constrained. While a
minimum revenue amount stated in a contract may help an entity estimate
this amount, management should not choose by default to make its
estimate the minimum amount stated in the contract since there may be an
amount of variable consideration in excess of that minimum for which it
is probable that a significant reversal of revenue will not occur once
the uncertainty is resolved.
Example 23 in ASC 606 (reproduced below) illustrates how an entity evaluates the
constraint on estimates of variable consideration in the determination of the
transaction price at the contract level.
ASC 606-10
Example 23 — Price Concessions
55-208 An entity enters into
a contract with a customer, a distributor, on December
1, 20X7. The entity transfers 1,000 products at contract
inception for a price stated in the contract of $100 per
product (total consideration is $100,000). Payment from
the customer is due when the customer sells the products
to the end customers. The entity’s customer generally
sells the products within 90 days of obtaining them.
Control of the products transfers to the customer on
December 1, 20X7.
55-209 On the basis of its
past practices and to maintain its relationship with the
customer, the entity anticipates granting a price
concession to its customer because this will enable the
customer to discount the product and thereby move the
product through the distribution chain. Consequently,
the consideration in the contract is variable.
Case A — Estimate of Variable
Consideration Is Not Constrained
55-210 The entity has
significant experience selling this and similar
products. The observable data indicate that historically
the entity grants a price concession of approximately 20
percent of the sales price for these products. Current
market information suggests that a 20 percent reduction
in price will be sufficient to move the products through
the distribution chain. The entity has not granted a
price concession significantly greater than 20 percent
in many years.
55-211 To estimate the
variable consideration to which the entity will be
entitled, the entity decides to use the expected value
method (see paragraph 606-10-32-8(a)) because it is the
method that the entity expects to better predict the
amount of consideration to which it will be entitled.
Using the expected value method, the entity estimates
the transaction price to be $80,000 ($80 × 1,000
products).
55-212 The entity also
considers the guidance in paragraphs 606-10-32-11
through 32-13 on constraining estimates of variable
consideration to determine whether the estimated amount
of variable consideration of $80,000 can be included in
the transaction price. The entity considers the factors
in paragraph 606-10-32-12 and determines that it has
significant previous experience with this product and
current market information that supports its estimate.
In addition, despite some uncertainty resulting from
factors outside its influence, based on its current
market estimates, the entity expects the price to be
resolved within a short time frame. Thus, the entity
concludes that it is probable that a significant
reversal in the cumulative amount of revenue recognized
(that is, $80,000) will not occur when the uncertainty
is resolved (that is, when the total amount of price
concessions is determined). Consequently, the entity
recognizes $80,000 as revenue when the products are
transferred on December 1, 20X7.
Case B — Estimate of Variable
Consideration Is Constrained
55-213 The entity has
experience selling similar products. However, the
entity’s products have a high risk of obsolescence, and
the entity is experiencing high volatility in the
pricing of its products. The observable data indicate
that historically the entity grants a broad range of
price concessions ranging from 20 to 60 percent of the
sales price for similar products. Current market
information also suggests that a 15 to 50 percent
reduction in price may be necessary to move the products
through the distribution chain.
55-214 To estimate the
variable consideration to which the entity will be
entitled, the entity decides to use the expected value
method (see paragraph 606-10-32-8(a)) because it is the
method that the entity expects to better predict the
amount of consideration to which it will be entitled.
Using the expected value method, the entity estimates
that a discount of 40 percent will be provided and,
therefore, the estimate of the variable consideration is
$60,000 ($60 × 1,000 products).
55-215 The entity also
considers the guidance in paragraphs 606-10-32-11
through 32-13 on constraining estimates of variable
consideration to determine whether some or all of the
estimated amount of variable consideration of $60,000
can be included in the transaction price. The entity
considers the factors in paragraph 606-10-32-12 and
observes that the amount of consideration is highly
susceptible to factors outside the entity’s influence
(that is, risk of obsolescence) and it is likely that
the entity may be required to provide a broad range of
price concessions to move the products through the
distribution chain. Consequently, the entity cannot
include its estimate of $60,000 (that is, a discount of
40 percent) in the transaction price because it cannot
conclude that it is probable that a significant reversal
in the amount of cumulative revenue recognized will not
occur. Although the entity’s historical price
concessions have ranged from 20 to 60 percent, market
information currently suggests that a price concession
of 15 to 50 percent will be necessary. The entity’s
actual results have been consistent with then-current
market information in previous, similar transactions.
Consequently, the entity concludes that it is probable
that a significant reversal in the cumulative amount of
revenue recognized will not occur if the entity includes
$50,000 in the transaction price ($100 sales price and a
50 percent price concession) and, therefore, recognizes
revenue at that amount. Therefore, the entity recognizes
revenue of $50,000 when the products are transferred and
reassesses the estimates of the transaction price at
each reporting date until the uncertainty is resolved in
accordance with paragraph 606-10-32-14.
Note that in the Codification example above, it is assumed as
part of the fact pattern that control of the products is transferred to the
distributor at contract inception. However, the fact that the distributor
becomes obliged to pay for the products only when it sells them to end customers
is an indication that this might be a consignment arrangement. Consignment
arrangements are discussed in Section 8.6.8.
6.3.3.1 Constraint on Variable Consideration Assessed at the Contract Level
As described in Section 3.1.2, the transaction price
for the contract is determined in step 3 of the revenue model and, hence,
the unit of account for determining the transaction price is the contract
level. The revenue constraint forms part of the determination of the
transaction price; accordingly, the likelihood and significance of a
potential revenue reversal should be assessed at the contract level
Example 6-4
An entity enters into a contract
with a customer to provide equipment and consulting
services. The contractual price for the equipment is
$10 million. The consulting services are priced at a
fee of $100,000, of which $55,000 is fixed and
$45,000 is contingent on the customer’s reducing its
manufacturing costs by 5 percent over a one-year
period.
It is also concluded that:
-
The equipment and consulting services are separate performance obligations.
-
The stand-alone selling prices of the equipment and consulting services are $10 million and $100,000, respectively.
The entity believes that there is a
60 percent likelihood that it will be entitled to
the performance-based element of the consulting
services fee. As a result, by using the most likely
amount approach described in ASC 606-10-32-8(b), the
entity estimates the amount of the variable
consideration as $45,000.
The total transaction price of the
contract before the entity considers the constraint
is, therefore, $10.1 million.
The entity then considers the
constraint to determine whether it is probable that
a significant reversal in the amount of cumulative
revenue recognized will not occur. The entity
considers both the likelihood and the magnitude of a
revenue reversal at the contract level.
There is a 40 percent chance that
the contingent consulting services fee of $45,000
will not be receivable. Accordingly, the entity
concludes that it is not probable that the entity
will be entitled to the variable consideration.
However, the significance of the potential revenue
reversal of $45,000 is evaluated in the context of
the contract ($45,000 as a proportion of $10.1
million, or 0.45 percent of the transaction price)
and not in the context of the performance obligation
($45,000 as a proportion of $100,000, or 45 percent
of the amount assigned to the performance
obligation). Therefore, the entity concludes that
all of the variable consideration should be included
in the transaction price because it is probable that
a significant revenue reversal will not
occur.
The above issue is addressed in Implementation Q&A 30 (compiled from previously
issued TRG Agenda Papers 14 and 25). For additional information and Deloitte’s summary
of issues discussed in the Implementation Q&As, see Appendix C.
6.3.3.2 Estimating Multiple Elements of Variable Consideration and Assessing the Constraint on Variable Consideration
As stated in Section 6.3.2.3, Example 21 in ASC
606-10-55-197 through 55-200 shows that when a contract contains multiple
elements of variability (e.g., sales returns, discounts, performance
bonuses), an entity should prepare a separate estimate for each element of
variable consideration in a contract (i.e., for each uncertainty) by using
either the expected value method or the most likely amount method, whichever
method better predicts the amount of consideration to which it will be
entitled. Since the revenue constraint forms part of the determination of
the transaction price, the likelihood and significance of a potential
revenue reversal should be assessed at the contract level. Therefore, it is
important for entities to be aware of the distinction between (1) preparing
separate estimates for each element of variable consideration in a
contract and (2) separately evaluating the constraint on estimates of
variable consideration in the determination of the transaction price at the
contract level.
Example 25 in ASC 606 (reproduced below) illustrates how an entity evaluates
the constraint on estimates of each element of variable consideration in the
determination of the transaction price at the contract level.
ASC 606-10
Example 25 — Management Fees Subject
to the Constraint
55-221 On January 1, 20X8, an
entity enters into a contract with a client to
provide asset management services for five years.
The entity receives a 2 percent quarterly management
fee based on the client’s assets under management at
the end of each quarter. In addition, the entity
receives a performance-based incentive fee of 20
percent of the fund’s return in excess of the return
of an observable market index over the 5-year
period. Consequently, both the management fee and
the performance fee in the contract are variable
consideration.
55-222 The entity accounts
for the services as a single performance obligation
in accordance with paragraph 606-10-25-14(b),
because it is providing a series of distinct
services that are substantially the same and have
the same pattern of transfer (the services transfer
to the customer over time and use the same method to
measure progress — that is, a time-based measure of
progress).
55-223 At contract inception,
the entity considers the guidance in paragraphs
606-10-32-5 through 32-9 on estimating variable
consideration and the guidance in paragraphs
606-10-32-11 through 32-13 on constraining estimates
of variable consideration, including the factors in
paragraph 606-10-32-12. The entity observes that the
promised consideration is dependent on the market
and, thus, is highly susceptible to factors outside
the entity’s influence. In addition, the incentive
fee has a large number and a broad range of possible
consideration amounts. The entity also observes that
although it has experience with similar contracts,
that experience is of little predictive value in
determining the future performance of the market.
Therefore, at contract inception, the entity cannot
conclude that it is probable that a significant
reversal in the cumulative amount of revenue
recognized would not occur if the entity included
its estimate of the management fee or the incentive
fee in the transaction price.
55-224 At each reporting
date, the entity updates its estimate of the
transaction price. Consequently, at the end of each
quarter, the entity concludes that it can include in
the transaction price the actual amount of the
quarterly management fee because the uncertainty is
resolved. However, the entity concludes that it
cannot include its estimate of the incentive fee in
the transaction price at those dates. This is
because there has not been a change in its
assessment from contract inception — the variability
of the fee based on the market index indicates that
the entity cannot conclude that it is probable that
a significant reversal in the cumulative amount of
revenue recognized would not occur if the entity
included its estimate of the incentive fee in the
transaction price. At March 31, 20X8, the client’s
assets under management are $100 million. Therefore,
the resulting quarterly management fee and the
transaction price is $2 million.
55-225 At the end of each
quarter, the entity allocates the quarterly
management fee to the distinct services provided
during the quarter in accordance with paragraphs
606-10-32-39(b) and 606-10-32-40. This is because
the fee relates specifically to the entity’s efforts
to transfer the services for that quarter, which are
distinct from the services provided in other
quarters, and the resulting allocation will be
consistent with the allocation objective in
paragraph 606-10-32-28. Consequently, the entity
recognizes $2 million as revenue for the quarter
ended March 31, 20X8.
6.3.4 Evaluating the Impact of Subsequent Events on Estimates of Variable Consideration
In certain circumstances, the uncertainty related to variable
consideration may be resolved shortly after the end of the reporting period.
When additional information (e.g., regulatory approval notification or denial)
is received after the end of the reporting period and before the date on which
financial statements are issued or available to be issued, an entity should
refer to the guidance in ASC 855 on accounting for subsequent events. Paragraph
BC228 of ASU 2014-09 states the following:
The Boards noted that in some cases, an entity might make an estimate of
the amount of variable consideration to include in the transaction price
at the end of a reporting period. However, information relating to the
variable consideration might arise between the end of the reporting
period and the date when the financial statements are authorized for
issue. The Boards decided not to provide guidance on the accounting in
these situations because they noted that the accounting for subsequent
events is already addressed in Topic 855, Subsequent Events, and IAS 10,
Events after the Reporting Period.
ASC 855 distinguishes between recognized subsequent events (ASC 855-10-25-1) and
nonrecognized subsequent events (ASC 855-10-25-3) as follows:
25-1 An entity shall recognize in the financial statements the
effects of all subsequent events that provide additional evidence about
conditions that existed at the date of the balance sheet, including the
estimates inherent in the process of preparing financial statements. See
paragraph 855-10-55-1 for examples of recognized subsequent events.
25-3 An entity shall not recognize subsequent events that provide
evidence about conditions that did not exist at the date of the balance
sheet but arose after the balance sheet date but before financial
statements are issued or are available to be issued. See paragraph
855-10-55-2 for examples of nonrecognized subsequent events.
In the life sciences industry, it is common for a life sciences entity to enter
into a contract with a customer that entitles the life sciences entity to
variable consideration in the event that the customer receives regulatory
approval as a result of the R&D activities performed by the life sciences
entity. Because the variable consideration is contingent on the customer’s
receipt of regulatory approval, the life sciences entity is required to estimate
the amount of variable consideration to include in the transaction price. The
life sciences entity may conclude that such variable consideration should be
constrained until regulatory approval is obtained.
However, ASC 855 does not provide direct guidance on how to account for
additional information about regulatory approval or denial that is received
after the end of the reporting period and before the date on which the financial
statements are issued or are available to be issued. We believe that the
conclusion to account for information received about the regulatory approval
process as either a recognized or a nonrecognized subsequent event will be based
on the facts and circumstances and may require significant judgment.
Accordingly, entities are encouraged to consult with their accounting
advisers.
6.3.5 Application to Different Forms of Variable Consideration
6.3.5.1 Sales- or Usage-Based Royalties
ASC 606-10
32-13 An entity shall apply paragraph 606-10-55-65 to account for consideration in the form of a sales-based
or usage-based royalty that is promised in exchange for a license of intellectual property.
ASC 606-10-55-65 states that an entity may not recognize revenue from sales- or
usage-based royalties related to licenses of IP until the later of (1) the
subsequent sale or usage or (2) the satisfaction of the performance
obligation to which some or all of the royalty has been allocated. See Chapter 12 for further
discussion of sales- or usage-based royalties related to licenses of IP.
Consideration in the form of sales- or usage-based royalties is inherently
variable depending on future customer actions. However, the FASB and IASB
decided that the variability in the transaction price from sales- or
usage-based royalties related to licenses of IP should be accounted for
differently from the variability attributable to sales- or usage-based
royalties that are not related to licenses of IP (see Chapter 12 for further
discussion of licensing). Accordingly, ASC 606-10-55-65 effectively provides
that the requirements related to estimating and constraining variable
consideration are subject to an exception for sales- or usage-based
royalties related to licenses of IP.
It is important to note that sales- or usage-based royalties that are not
related to licenses of IP are still subject to the requirements related to
estimating and constraining variable consideration (discussed in Sections 6.3.2 and 6.3.3, respectively). In
light of this, the boards acknowledge in paragraph BC416 of ASU 2014-09 that
economically similar transactions could be accounted for differently (e.g.,
royalty arrangements not related to licenses of IP could result in timing
and amounts of revenue recognition that differ from those of royalty
arrangements related to licenses of IP).
6.3.5.2 Refund Liabilities
ASC 606-10
32-10 An entity shall
recognize a refund liability if the entity receives
consideration from a customer and expects to refund
some or all of that consideration to the customer. A
refund liability is measured at the amount of
consideration received (or receivable) for which the
entity does not expect to be entitled (that is,
amounts not included in the transaction price). The
refund liability (and corresponding change in the
transaction price and, therefore, the contract
liability) shall be updated at the end of each
reporting period for changes in circumstances. To
account for a refund liability relating to a sale
with a right of return, an entity shall apply the
guidance in paragraphs 606-10-55-22 through
55-29.
Refund liabilities are first introduced in ASC 606 as a form of variable
consideration — specifically, in ASC 606-10-32-10. That is, the fact that an
entity may have to refund to its customer some of the consideration it is
promised in the contract is a creator of variability in the amount of
consideration to which the entity is ultimately expected to be entitled in
exchange for delivering the goods or services in the contract. In ASC
606-10-32-10, the FASB expressly linked the accounting for refund
liabilities to their most common application, in sales with a right of
return (which are discussed in Section 6.3.5.3). However, there could
be other circumstances in which refund liabilities arise in revenue
contracts. Entities should carefully consider circumstances in which cash is
expected to be refunded to a customer when evaluating whether a refund
liability should be recognized.
In addition, as discussed in Section 14.3,
refund liabilities are to be presented separately from contract liabilities
in the balance sheet. Refund liabilities would generally not be presented in
Schedule II — Valuation and Qualifying Accounts as described in SEC
Regulation S-X, Rules 5-04 and 12-09.
Presentation of refund liabilities is further discussed in Chapter 14.
6.3.5.3 Sales With a Right of Return
ASC 606-10
55-22 In some contracts, an
entity transfers control of a product to a customer
and also grants the customer the right to return the
product for various reasons (such as dissatisfaction
with the product) and receive any combination of the
following:
-
A full or partial refund of any consideration paid
-
A credit that can be applied against amounts owed, or that will be owed, to the entity
-
Another product in exchange.
55-23 To account for the
transfer of products with a right of return (and for
some services that are provided subject to a
refund), an entity should recognize all of the
following:
-
Revenue for the transferred products in the amount of consideration to which the entity expects to be entitled (therefore, revenue would not be recognized for the products expected to be returned)
-
A refund liability
-
An asset (and corresponding adjustment to cost of sales) for its right to recover products from customers on settling the refund liability.
55-24 An entity’s promise to stand ready to accept a returned product during the return period should not be
accounted for as a performance obligation in addition to the obligation to provide a refund.
In paragraph BC363 of ASU 2014-09, the FASB and IASB acknowledge that
“conceptually, a contract with a right of return includes at least two
performance obligations — a performance obligation [i.e., the original
promise] to provide the good to the customer and a performance obligation
[i.e., a secondary promise] for the return right service, which is a
standready obligation to accept the goods returned by the customer during
the return period.” However, in paragraph BC366, the boards go on to note
that their ultimate conclusions about the implementation guidance on sales
with a right of return were driven by practical considerations such that the
boards “decided that the incremental information provided to users of
financial statements by accounting for the return right service as a
performance obligation would not have justified the complexities and costs
of doing so.” Thus, because “standing ready” to accept returns is not
regarded as a performance obligation in these circumstances, no revenue is
recognized as that activity occurs. Further, as with refund liabilities, the
return right service is viewed instead as a driver of variability in the
amount of consideration to which the entity expects to be entitled for
transferring the goods or services in the contract. See Section 5.2.4.2 for further discussion.
Importantly, under the revenue standard, a sale with a right of return is not a
separate variable consideration model or a “failed” sale model. Rather, the
uncertainty associated with whether a product may be returned is treated,
for measurement purposes, consistently with the uncertainty associated with
whether an entity will receive all or nothing from a bonus payment of $1
million. Accordingly, the boards decided against dealing with this
uncertainty through a step 5, transfer-of-control notion (i.e., a “failed”
sale model). In adopting this approach, the boards chose simplicity over
creating (1) several different categories of variable consideration and (2)
separate measurement models for each of those separate types of
variability.
As a result, although the boards provided more specific measurement and remeasurement guidance
for sales with a right of return in ASC 606-10-55-25 through 55-27 (paragraphs B23 through B25 of IFRS
15), the guidance remains consistent with the standard’s overall measurement principles for variable
consideration.
ASC 606-10
55-25 An entity should apply the guidance in paragraphs 606-10-32-2 through 32-27 (including the guidance
on constraining estimates of variable consideration in paragraphs 606-10-32-11 through 32-13) to determine
the amount of consideration to which the entity expects to be entitled (that is, excluding the products expected
to be returned). For any amounts received (or receivable) for which an entity does not expect to be entitled,
the entity should not recognize revenue when it transfers products to customers but should recognize those
amounts received (or receivable) as a refund liability. Subsequently, at the end of each reporting period,
the entity should update its assessment of amounts for which it expects to be entitled in exchange for the
transferred products and make a corresponding change to the transaction price and, therefore, in the amount
of revenue recognized.
55-26 An entity should update the measurement of the refund liability at the end of each reporting period for
changes in expectations about the amount of refunds. An entity should recognize corresponding adjustments
as revenue (or reductions of revenue).
55-27 An asset recognized for an entity’s right to recover products from a customer on settling a refund liability
initially should be measured by reference to the former carrying amount of the product (for example, inventory)
less any expected costs to recover those products (including potential decreases in the value to the entity of
returned products). At the end of each reporting period, an entity should update the measurement of the
asset arising from changes in expectations about products to be returned. An entity should present the asset
separately from the refund liability.
55-28 Exchanges by customers of one product for another of the same type, quality, condition, and price (for
example, one color or size for another) are not considered returns for the purposes of applying the guidance in
this Topic.
55-29 Contracts in which a
customer may return a defective product in exchange
for a functioning product should be evaluated in
accordance with the guidance on warranties in
paragraphs 606-10-55-30 through 55-35.
6.3.5.3.1 Estimating the Transaction Price When an Entity Promises to Stand Ready to Accept a Returned Product During the Return Period and Provide a Refund
When an entity promises to stand ready to accept a
returned product during the return period and provide a refund, the
transaction price should be estimated in the same way as any other
variable consideration (see Example 22 in ASC 606-10-55-202 through
55-207 below) and should reflect the amount to which the entity expects
to be entitled. The entity should adjust that amount to exclude amounts
expected to be reimbursed or credited to customers by using either the
most likely amount or the expected value method (as discussed in
Section 6.3.2.1).
For example, when a retail store has a policy that
allows customers to return a product within 30 days (for any reason), no
amount of the transaction price is allocated to the “service” of
standing ready to accept the returned product. Instead, the transaction
price is estimated and constrained to the amount for which the entity
expects it is probable that significant reversal will not occur when the
uncertainty associated with expected returns is resolved. An adjustment
to revenue will then be recognized when the level of returns is known
after 30 days or by updating the estimated transaction price as of any
reporting date falling within that period. This is illustrated by
Example 22 in ASC 606-10-55-202 through 55-207, which is reproduced
below.
ASC 606-10
Example 22 — Right of Return
55-202 An entity enters into
100 contracts with customers. Each contract
includes the sale of 1 product for $100 (100 total
products × $100 = $10,000 total consideration).
Cash is received when control of a product
transfers. The entity’s customary business
practice is to allow a customer to return any
unused product within 30 days and receive a full
refund. The entity’s cost of each product is
$60.
55-203 The entity applies the
guidance in this Topic to the portfolio of 100
contracts because it reasonably expects that, in
accordance with paragraph 606-10-10-4, the effects
on the financial statements from applying this
guidance to the portfolio would not differ
materially from applying the guidance to the
individual contracts within the portfolio.
55-204 Because the contract
allows a customer to return the products, the
consideration received from the customer is
variable. To estimate the variable consideration
to which the entity will be entitled, the entity
decides to use the expected value method (see
paragraph 606-10-32-8(a)) because it is the method
that the entity expects to better predict the
amount of consideration to which it will be
entitled. Using the expected value method, the
entity estimates that 97 products will not be
returned.
55-205 The entity also
considers the guidance in paragraphs 606-10-32-11
through 32-13 on constraining estimates of
variable consideration to determine whether the
estimated amount of variable consideration of
$9,700 ($100 × 97 products not expected to be
returned) can be included in the transaction
price. The entity considers the factors in
paragraph 606-10-32-12 and determines that
although the returns are outside the entity’s
influence, it has significant experience in
estimating returns for this product and customer
class. In addition, the uncertainty will be
resolved within a short time frame (that is, the
30-day return period). Thus, the entity concludes
that it is probable that a significant reversal in
the cumulative amount of revenue recognized (that
is, $9,700) will not occur as the uncertainty is
resolved (that is, over the return period).
55-206 The entity estimates
that the costs of recovering the products will be
immaterial and expects that the returned products
can be resold at a profit.
55-207 Upon transfer of
control of the 100 products, the entity does not
recognize revenue for the 3 products that it
expects to be returned. Consequently, in
accordance with paragraphs 606-10-32-10 and
606-10-55-23, the entity recognizes the
following:
6.3.5.3.2 Accounting for Restocking Fees and Related Costs
In some industries, customers are not entitled to a full
refund if they return a previously purchased product to the seller. In
effect, the seller charges a fee for accepting returns, sometimes
referred to as a “restocking” fee. Restocking fees are typically stated
in the contract between the seller and the customer.
Restocking fees can serve a number of purposes for the
seller, including (1) to recover some of the costs the seller expects to
incur in returning such product to saleable inventory (e.g., repackaging
or shipping costs), (2) to mitigate a potential reduced selling price
upon resale, and (3) to discourage customers from returning
products.
Restocking fees for expected returns should be included
in the transaction price. When accounting for restocking fees, an entity
will need to consider the guidance in ASC 606-10-32-5 through 32-9 on
estimating variable consideration.
In accordance with ASC 606-10-55-27, the costs expected
to be incurred when the products are returned should be recognized as of
the date on which control is transferred to the customer as a reduction
of the carrying amount of the asset expected to be recovered.
Example 6-5
Entity X enters into a contract
with Customer Y to sell 10 widgets for $100 each
in cash. The cost of each widget to X is $75.
Customer Y has the right to return a widget but
will be charged a restocking fee of 10 percent
(i.e., $10 per widget). Entity X expects to incur
costs of $5 per widget to ship and repackage each
item returned before it can be resold.
Entity X concludes that because
a right of return exists, the consideration
promised under the contract includes a variable
amount. Entity X uses the expected value method
for estimating the variable consideration and
estimates that (1) 10 percent of the widgets will
be returned and (2) it is probable that returns
will not exceed 10 percent. Entity X also expects
that the returned widgets can be resold at a
profit.
When control of the 10 widgets
is transferred to the customer, X therefore
recognizes revenue of $900 for 9 widgets sold
($100 × 9) and also includes the restocking fee
for 1 widget of $10 ($100 × 10%) in the
transaction price. Entity X also recognizes a
refund liability of $90 for the 1 widget that is
expected to be returned ($100 transaction price
less $10 restocking fee). This analysis is
reflected in the following journal entry:
On the cost side:
In accordance with ASC
606-10-55-27, X recognizes an asset for its right
to recover the widget from Y on settlement of the
refund liability. The asset is measured at the
former carrying amount of the inventory items as
reduced by the expected costs to recover the
product. Entity X therefore recognizes an asset of
$70 ($75 cost less $5 restocking cost).
The cost of sales is $680, which
is the aggregate of (1) the cost of items sold and
not expected to be returned of $675 (9 widgets ×
$75) and (2) the anticipated restocking cost of
$5.
This cost analysis is reflected
in the following journal entry:
When the widget is returned by
Y, $90 is refunded. The widget is returned to
inventory. Entity X incurs the restocking cost and
includes that cost in the inventory amount as
follows:
The above issue is addressed in Implementation Q&As 42 and 77 (compiled from
previously issued TRG Agenda Papers 35 and 44). For additional information and Deloitte’s
summary of issues discussed in the Implementation Q&As, see Appendix C.
6.3.5.4 Variable Consideration Driven by Variable Volumes
6.3.5.4.1 Distinguishing Between Optional Purchases and Variable Consideration
Under the revenue standard, an entity must determine its
contractual rights and obligations, including whether options for future
goods or services give rise to performance obligations under a current
contract with a customer (see Chapter 11). In considering how to
apply the guidance on optional purchases for which an entity does not
identify a material right, stakeholders have questioned whether and, if
so, when customer options to acquire additional goods or services would
be considered (1) a separate contract that arises when the option is
exercised or (2) variable consideration for which an entity would be
required to estimate the amount of consideration to include in the
original contract’s transaction price (subject to the standard’s
constraint on variable consideration). That is, stakeholders have raised
questions about when an entity, as part of determining its transaction
price, should estimate customers’ future purchases that may be made
under options for additional goods or services.
The revenue standard does not require or allow an entity
to estimate the transaction price of future contracts into which it will
enter with a customer. This assertion is supported by the FASB and IASB
in paragraph BC186 of ASU 2014-09, which states that “the transaction
price should include only amounts (including variable amounts) to which
the entity has rights under the present
contract” (emphasis added).
Further, an entity should perform an evaluation of the
nature of its promises in a contract with a customer, including a
careful evaluation of the enforceable rights and obligations in the
present contract (not future contracts). That is, there is a distinction
between (1) customer options and (2) uncertainty that is accounted for
as variable consideration.
Customer options are predicated on a separate customer
action (namely, the customer’s decision to exercise the option), which
would not be embodied in the present contract; unless an option is a
material right, such options would not factor into the accounting for
the present contract. If an option to acquire additional goods or
services represents a material right, part of the transaction price is
allocated to that material right, and recognition of a portion of
revenue is deferred (see ASC 606-10-55-41 through 55-45). The additional
goods or services are not themselves performance obligations under the
contract; instead, the option to acquire them is treated as a
performance obligation if it represents a material right.
Enforceable rights and obligations in a contract are
only those for which the entity has legal rights and obligations under
the contract and would not take economic or other penalties into account
(e.g., (1) economic compulsion or (2) exclusivity because the entity is
the sole provider of the goods or services, which may make the future
deliverables highly probable of occurring). Section 11.4 further expands on this view.
In contrast, uncertainty is accounted for as variable
consideration when the entity has enforceable rights and obligations
under a present contract to provide goods or services without an
additional customer decision. ASC 606 deals separately with the
appropriate accounting for “variable consideration” when the
consideration promised in a contract includes a variable amount (see ASC
606-10-32-5 through 32-14). For example, there may be uncertainty in a
long-term contract that includes variability because of other factors
(e.g., variable quantities that affect the consideration due under the
contract). Entities should consider the need to take variability of this
nature into account in determining the transaction price.
An entity will need to evaluate the nature of its
promises under a contract and use judgment to determine whether the
contract includes (1) an option to purchase additional goods or services
(which the entity would need to evaluate for a material right) or (2) a
single performance obligation for which the quantity of goods or
services to be transferred is not fixed at the outset (which would give
rise to variable consideration).
In exercising such judgment, an entity may find the
following indicators helpful:
-
A determination that an entity’s customer can make a separate purchasing decision with respect to additional distinct goods or services and that the entity is not obliged to provide those goods or services before the customer exercises its rights would be indicative of an option for additional goods or services. For example, suppose that an entity enters into a five-year exclusive master supply agreement with a customer related to components that the customer uses in its products. The customer may purchase components at any time during the term of the agreement, but it is not obliged to purchase any components. Each time the customer elects to purchase a component from the entity represents a separate performance obligation of the entity.
-
Conversely, if future events (which may include a customer’s own actions) will not oblige an entity to provide a customer with additional distinct goods or services, any additional consideration triggered by those events would be accounted for as variable consideration. For example, suppose that an entity agrees to process all transactions for a customer in exchange for fees that are based on the volume of transactions processed, but the volume of transactions is not known at the outset and is outside the control of both the entity and the customer. The performance obligation is to provide the customer with continuous access to transaction processing for the contract period. The additional transactions processed are not distinct services; rather, they are part of the satisfaction of the single performance obligation to process transactions, and the variability in transactions processed results in variable consideration.
The above issue is addressed in Implementation Q&A 23 (compiled from previously
issued TRG Agenda Papers 48 and 49). For additional information and Deloitte’s
summary of issues discussed in the Implementation Q&As, see
Appendix
C.
6.3.5.4.2 Volume-Based Rebates
An entity may offer its customers rebates or discounts
on the pricing of products or services once specific volume thresholds
have been met. That is, an entity may either retrospectively or
prospectively adjust the price of its goods or services once a certain
volume threshold has been met.
A volume rebate or discount that is retrospectively applied should
be accounted for under ASC 606 as variable consideration (rather than as
a customer option to be evaluated as a potential material right). In
accordance with ASC 606-10-32-6, which specifically includes discounts
and rebates as a form of variable consideration, the “promised
consideration also can vary if an entity’s entitlement to the
consideration is contingent on the occurrence or nonoccurrence of a
future event” (emphasis added).
However, an offer to prospectively lower the price per unit (once
certain volume thresholds are met) should not be accounted for as
variable consideration. Rather, when a volume rebate or discount is
applied prospectively, an entity will need to evaluate the facts
and circumstances of each contract to determine whether the rebate or
discount represents a material right and therefore should be accounted
for as a performance obligation. As part of this evaluation, the entity
would consider whether the offer to the customer is at a price that
would reflect the stand-alone selling price for that good or service, in
accordance with ASC 606-10-55-43.
Example 24 in the revenue standard (ASC 606-10-55-216
through 55-220) illustrates how an entity would account for a volume
discount incentive as variable consideration.
ASC 606-10
Example 24 — Volume Discount
Incentive
55-216 An entity enters into
a contract with a customer on January 1, 20X8, to
sell Product A for $100 per unit. If the customer
purchases more than 1,000 units of Product A in a
calendar year, the contract specifies that the
price per unit is retrospectively reduced to $90
per unit. Consequently, the consideration in the
contract is variable.
55-217 For the first quarter
ended March 31, 20X8, the entity sells 75 units of
Product A to the customer. The entity estimates
that the customer’s purchases will not exceed the
1,000-unit threshold required for the volume
discount in the calendar year.
55-218 The entity considers
the guidance in paragraphs 606-10-32-11 through
32-13 on constraining estimates of variable
consideration, including the factors in paragraph
606-10-32-12. The entity determines that it has
significant experience with this product and with
the purchasing pattern of the entity. Thus, the
entity concludes that it is probable that a
significant reversal in the cumulative amount of
revenue recognized (that is, $100 per unit) will
not occur when the uncertainty is resolved (that
is, when the total amount of purchases is known).
Consequently, the entity recognizes revenue of
$7,500 (75 units × $100 per unit) for the quarter
ended March 31, 20X8.
55-219 In May 20X8, the
entity’s customer acquires another company and in
the second quarter ended June 30, 20X8, the entity
sells an additional 500 units of Product A to the
customer. In light of the new fact, the entity
estimates that the customer’s purchases will
exceed the 1,000-unit threshold for the calendar
year and, therefore, it will be required to
retrospectively reduce the price per unit to
$90.
55-220 Consequently, the
entity recognizes revenue of $44,250 for the
quarter ended June 30, 20X8. That amount is
calculated from $45,000 for the sale of 500 units
(500 units × $90 per unit) less the change in
transaction price of $750 (75 units × $10 price
reduction) for the reduction of revenue relating
to units sold for the quarter ended March 31, 20X8
(see paragraphs 606-10-32-42 through 32-43).
Example 6-6
Rebate
Applied Retrospectively
Entity X enters into a contract
with a customer to supply widgets. Under the terms
of the contract, each widget is sold for $10, but
if the customer purchases more than 100 widgets in
a calendar year, the price will be reduced
retrospectively to $8 per widget. The contract
does not include any minimum purchase
commitments.
In this example, the volume
rebate of $2 is applied retrospectively. It should
be accounted for as variable consideration under
ASC 606-10-32-5 through 32-14 because X’s
entitlement to consideration for each unit sold is
contingent on the occurrence of a future event
(i.e., the customer’s buying more than 100
units).
Accordingly, X is required to
estimate the amount of consideration to which it
will be entitled for each widget by using either
the expected value method or the most likely
amount (whichever is considered to better predict
the amount of consideration to which X will be
entitled). The $2 variable consideration should
only be included in the transaction price if it is
probable that a significant reversal in the amount
of cumulative revenue recognized will not occur
(i.e., it is likely that the customer will not
purchase more than 100 units).
Example 6-7
Rebate
Applied Prospectively
Entity Y enters into a contract
with a customer to supply widgets. Under the terms
of the contract, each widget is sold for $10, but
if the customer purchases more than 100 widgets in
a calendar year, the price will be reduced
prospectively to $8 per widget (i.e., the $8 price
applies only for subsequent purchases). The
contract does not include any minimum purchase
commitments.
In this example, the customer
has an option to purchase additional widgets at a
reduced price of $8 per unit, which should be
accounted for in accordance with ASC 606-10-55-41
through 55-45. Entity Y will need to evaluate the
facts and circumstances to determine whether the
option gives rise to a performance obligation. The
option would give rise to a performance obligation
if it provides a material right to the customer
that the customer would not receive without
purchasing the first 100 units. As part of this
evaluation, Y should consider whether the reduced
price offered to the customer ($8 per unit)
reflects the stand-alone selling price for the
widgets, in accordance with ASC 606-10-55-43.
Example 6-8
Reassessment
of Volume Discounts Applied
Retrospectively
Assume the same facts as those
in Example
6-6, as well as the following
additional information:
-
Entity X initially estimated total widget sales of 90 items. The $2 variable consideration was included in the transaction price because X believed that it was probable that a significant reversal in the amount of cumulative revenue recognized would not occur (i.e., it was likely that the customer would not purchase more than 100 units).
-
Entity X sells 10 units during the first quarter, sells 20 units during the second quarter, and sells 60 units during the third quarter.
-
In light of recent sales activity, X increases its estimate of total sales volume for the year to 120 units.
In this example, X will be
required to effectively reduce the price per unit
to $8. Accordingly, X should update its
calculation of the transaction price to reflect
the change in estimate. The updated transaction
price is $8 per unit, which is based on the recent
increase in sales activity and updated sales
volume. Therefore, X should recognize revenue of
$420 for the third quarter, which is calculated as
follows:
6.3.5.5 Other Forms of Variability
6.3.5.5.1 Contracts That Include Consideration in a Foreign Currency
Despite the broad definition of variable consideration
in ASC 606, consideration that is fixed in a foreign currency (i.e., a
currency other than the entity’s functional currency) should not be
considered variable consideration. This is because the amount of
consideration promised in the contract does not vary; instead, that
fixed amount of consideration is retranslated into a variable amount of
the entity’s functional currency.
Therefore, an entity is not required to consider whether potential future
adverse movements in the exchange rate could result in a requirement to
limit the amount of revenue recognized in accordance with ASC
606-10-32-11. Instead, the principles of ASC 830 should be applied.
6.3.5.5.2 Variable Consideration in Real Estate Sales
A real estate sales contract may allow the seller to
participate in future profits related to the underlying real estate. As
discussed in Sections
6.3.2 and 6.3.3, some or all of the
estimated variable consideration is included in the transaction price
(and therefore eligible for recognition) to the extent that it is
probable that the cumulative amount of the revenue recognized will not
be subject to significant reversal.
Accordingly, an entity will need to estimate the portion
of the contingent (or variable) consideration to include in the
transaction price, which may be recognized when the performance
obligation is satisfied.
For example, suppose that an entity sells land to a home
builder for a fixed amount plus a percentage of the profits that will be
realized on the sale of homes once constructed on the land by the home
builder. Under the revenue standard, the entity would be required to (1)
estimate the consideration expected to be received from the home builder
and (2) recognize all or some of the amount as revenue (or other gains
and losses, if the transaction is with a noncustomer) up front when the
land is sold. Determining the amount of revenue that is not subject to a
significant revenue reversal could require significant judgment.
Further, an entity that has entered into a real estate sales contract may
need to consider whether the contract contains a significant financing
component (see Section 6.4).
6.3.5.5.3 Cash Discounts for Early Payment
Cash discounts for early payment are a form of variable
consideration. This is because the amount of consideration to which an
entity is entitled in these arrangements depends on a customer’s actions
(i.e., a customer’s decision to pay amounts due in time to take
advantage of an early payment discount). The example below illustrates
how a seller would account for a cash discount it provides to a customer
for making an early payment.
Example 6-9
Entity X offers Customer Y a
cash discount for immediate or prompt payment
(i.e., earlier than required under the normal
credit terms). A sale is made for $100 with the
balance due within 90 days. If Y pays within 30
days, Y will receive a 10 percent discount on the
total invoice. Entity X sells a large volume of
similar items on these credit terms (i.e., this
transaction is part of a portfolio of similar
items). Entity X has elected to apply the
practical expedient in ASC 606-10-32-18 and
therefore will not adjust the promised amount of
consideration for the effects of a significant
financing component.
In the circumstances described,
revenue is $100 if the discount is not taken and
$90 if the discount is taken. As a result, the
amount of consideration to which X will be
entitled is variable.
Therefore, X should recognize
revenue when or as the performance obligation is
satisfied net of the amount of cash discount
expected to be taken. To determine the amount of
revenue to be recognized, X should use either the
“expected value” or the “most likely amount”
method and consider the effect of the
constraint.
For example, if the discount is
taken in 40 percent of transactions, the expected
value will be calculated as follows:
($100 × 60%) + ($90 × 40%) =
$96
If the proportion of
transactions for which the discount is taken is
always close to 40 percent (i.e., it is within a
narrow range of around 40 percent), it is likely
that the estimate of variable consideration will
not need to be constrained, and revenue of $96
will be recognized.
If, however, the proportion of
transactions for which the discount is taken
varies significantly, it may be necessary to apply
the constraint, which will result in the
recognition of less revenue. For example,
historical records might show that although the
long-term average is 40 percent, there is great
variability from month to month and the proportion
of transactions for which the discount is taken is
frequently as high as 70 percent (but has never
been higher than that). In such a scenario, X
might conclude that only 30 percent of the
variable consideration should be included, because
inclusion of a higher amount might result in a
significant revenue reversal. In that case, the
amount of revenue recognized would be constrained
as follows:
($100 × 30%) + ($90 × 70%) = $93
6.3.5.5.4 Accounting for “Trail Commissions”
Another form of variable consideration is trail
commissions. For example, in many arrangements between an insurance
agent and an insurance carrier, the insurance agent is entitled to
additional consideration in the form of trail commissions each time a
consumer renews an insurance policy with the insurance carrier. Although
the insurance agent may satisfy its performance obligation when it sells
an initial policy to a consumer (because it is not the insurance
carrier), the ultimate consideration to which the insurance agent is
entitled depends on how many times the consumer renews the policy with
the insurance carrier (renewals do not require additional performance by
the insurance agent). The example below illustrates how an insurance
agent would account for additional annual commissions earned for future
expected policy renewals.
Example 6-10
IA, an insurance agent, is engaged by IC, an
insurance carrier, to sell IC’s insurance to the
general public. IA is compensated by IC on a
“trail commission” basis, which means that in
addition to receiving an initial commission from
IC for every consumer IA signs up for IC’s
insurance at the time of purchase (e.g., a $100
initial commission), IA receives annual
commissions from IC in future years every time
those consumers renew their insurance policy with
IC (e.g., an additional $50 commission due upon
each annual renewal of the consumer’s insurance
policy).
IA makes many sales to consumers on behalf of IC
such that IA has a large pool of homogeneous
transactions with historical information about
consumer renewal patterns for insurance
policies.
IA does not have any ongoing obligation to
provide additional services to IC or to the
consumers after the initial sale of insurance.
The consideration promised in this arrangement
includes both fixed and variable amounts. The
initial commission of $100 due to IA upon signing
up a customer is fixed consideration and is
included in the transaction price. In addition,
the transaction price includes variable
consideration in the form of potential additional
commissions due ($50 per each additional year) if
and when the consumer subsequently renews the
insurance policy. In accordance with the guidance
in ASC 606-10-32-8, IA should estimate the
variable consideration. Since IA has a large pool
of homogeneous contracts on which to base its
estimate, the expected value approach is used.
IA should consider evidence from other, similar
contracts to develop an estimate of variable
consideration under the expected value method
since there is a population of data with which IA
can make such an estimate.
IA will also need to consider
the guidance in ASC 606-10-32-11 through 32-13 to
constrain the amount of variable consideration
that should be included in the transaction price.
In considering the factors in ASC 606-10-32-12
that could increase the likelihood or magnitude of
a significant revenue reversal, IA should use
judgment and take into account all relevant facts
and circumstances. This could mean looking to
historical experience with similar contracts to
(1) make judgments about the constraint on
variable consideration and (2) estimate the amount
that is not probable of a significant reversal.
The greater the likelihood of a reversal of the
estimated variable consideration, the greater the
likelihood that the estimate should be
constrained.
6.3.6 Reassessment of Variable Consideration
ASC 606-10
32-14 At the end of each
reporting period, an entity shall update the estimated
transaction price (including updating its assessment of
whether an estimate of variable consideration is
constrained) to represent faithfully the circumstances
present at the end of the reporting period and the
changes in circumstances during the reporting period.
The entity shall account for changes in the transaction
price in accordance with paragraphs 606-10-32-42 through
32-45.
After its initial estimate (and potential constraint) of variable consideration at contract inception, an
entity must reassess that estimate (and potential constraint) at the end of each reporting period as
the uncertainties underlying the variable consideration are resolved or more information about the
underlying uncertainties is known. As noted in paragraph BC224 of ASU 2014-09, the FASB and IASB
“decided that an entity should update its estimate of the transaction price throughout the contract
[because] reflecting current assessments of the amount of consideration to which the entity expects to
be entitled will provide more useful information to users of financial statements.”
However, like the assessment of the transaction price at contract inception,
reassessment of the transaction price is part of a three-step process for
recognizing revenue. That is, once an entity updates an estimate (and potential
constraint) of variable consideration after inception, it generally must
reallocate the transaction price in accordance with step 4, in the same
proportions used in the allocation of the transaction price at inception, to the
performance obligations identified in step 2 so that revenue can be recognized
in step 5 when (or as) the entity satisfies a performance obligation.3 The example below illustrates how this guidance would be applied
Example 6-11
Assume that an entity enters into a contract with a customer for the delivery of
three performance obligations, PO1, PO2, and PO3. The
consideration in the contract is wholly variable for an
amount up to $600, and the entity’s estimate of variable
consideration at contract inception is $300. The entity
determines that a constraint of its estimate of variable
consideration is unnecessary. The stand-alone selling
prices of the three performance obligations are as
follows:
-
PO1 = $100.
-
PO2 = $200.
-
PO3 = $300.
Accordingly, the entity allocates the estimate of variable consideration to the performance obligations on a
relative stand-alone selling price basis as follows:
- PO1 = $100 ÷ $600 × $300 = $50.
- PO2 = $200 ÷ $600 × $300 = $100.
- PO3 = $300 ÷ $600 × $300 = $150.
If the uncertainty in the contract consideration is subsequently resolved (or
the entity’s estimate of variable consideration has
changed, subject to an assessment of the constraint) and
the entity determines that the updated transaction price
is $600, the entity reallocates the updated transaction
price to the performance obligations in proportion to
their relative stand-alone selling prices at contract
inception as follows:
-
PO1 = $100 ÷ $600 × $600 = $100.
-
PO2 = $200 ÷ $600 × $600 = $200.
-
PO3 = $300 ÷ $600 × $600 = $300.
The accounting for a change in the transaction price, including the guidance in
ASC 606-10-32-42 through 32-45 on reallocating that change, is further discussed
in Section 7.6.
Footnotes
1
Variable consideration would not need to be estimated if
an entity is applying (1) the invoice practical expedient to measure
progress toward complete satisfaction of a performance obligation (see
Section
8.5.8.1) or (2) the variable consideration allocation
exception in ASC 606-10-32-40 (see Section 7.5).
2
ASC 606-10-10-4 states that an
entity is permitted to use a portfolio approach as
a practical expedient to account for a group of
contracts with similar characteristics rather than
account for each contract individually. However,
an entity may only apply the practical expedient
if it does not expect the results of applying the
guidance in ASC 606 to a portfolio of contracts to
be materially different from the results of
applying that guidance to individual
contracts.
3
An entity would allocate variable consideration and
subsequent changes to it “entirely to a performance obligation or to a
distinct good or service that forms part of a single performance
obligation” if the criteria in ASC 606-10-32-40 are met.