Variable Consideration-One of the more difficult issues that companies face in r
ID: 2584057 • Letter: V
Question
Variable Consideration-One of the more difficult issues that companies face in recognizing revenue is determinin the transaction price. In cases where the consideration in a contract includes a variable amount, an entity should estimate the amount of consideration to which it is entitled in exchange for transferring the promised goods or services. Required: Discuss the methods a company may use to estimate variable consideration and the situations in which one method may be preferred over another
Explanation / Answer
A variable amount that is promised within a contract be included as a consideration. To this end, an entity should estimate the amount of the consideration to which it will be entitled in exchange for transferring the promised goods or services to a customer. Variable consideration includes discounts, credits, rebates, performance bonus, penalties, sales returns, refunds, price concessions, incentives etc.
The transaction price includes such variable considerations, whether explicitly stated in the contractor implicitly stated. A variable consideration exists even if the promised consideration is based upon the occurrence or non-occurrence of a future event.
A company may use the following two methods to estimate the variable consideration:
1) The Expected Value Approach- This method is the sum of probability-weighted amounts in a range of possible consideration amounts. This method is appropriate when the entity has a large number of contracts with similar characteristics.
2) The most likely amount- This method is appropriate when there is a single most likely outcome from the contract of the two possible outcomes.
An entity should select and apply one method consistently for similar types of contracts when estimating the variable consideration amount. In order to estimate the variable consideration, an entity should consider using historical data, current data or reasonable projections that are available at the time.
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