Revenue from Contracts with Customers, ASU 2014-09, provides framework for businesses to gather revenue and know when and how to report revenue. We have a series of posts concerning the framework laid out in the accounting update; previous posts can be found on the introduction, Step One, and Step Two of this update. We continue now with Step Three: Determining the Transaction Price. This step contains provisions which vary from current accounting principles in the U.S. thus alterations in accepted accounting practices may be necessary.
Step Three defines transaction price through ASU 606-10-32-2 as: the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties. Consideration can be fixed, variable, or a combination of the two. The price is allocated to identified performance obligations in the contract and these amounts are then recognized as revenue when the performance obligations are fulfilled. Prices are to be offered in estimation as what is expected to be paid, minus all potential discounts for products and services provided. Prices should be relatively straightforward, except when variable considerations, components, or complexities exist.
Timing, performance, and other factors affect the consideration, and therefore make it variable. Variable considerations come in the form of present or future outcomes such as discounts, refunds, rebates, incentives, credit, or other variables. If there is uncertainty in the variable consideration, a constraint on the consideration must be offered in conjunction. Common variable considerations that will be affected by this change in accounting are: price protection clauses, contract credits, performance bonuses, product returns, price concessions, consumer rebates, volume and prompt payment discounts. These transactions, which are considerations for the future, will require estimation at the time of inception. Point of sale discounts will not be affected by this policy and will not require updated accounting policies, as the amount of consideration is known at the time of transaction.
Future Potential Outcome
Previous patterns of purchasing, customer knowledge, considerations on rebate sustainability, and discount programs must be considered in future outcomes of transactions. Once transactions are deemed as future, there are two methods for estimating variable consideration:
- Expected value method – expected value is the sum of probability – weighted amounts in a range of possible consideration amounts. If the achievement of a variable discount is possible, but the amount of the variable consideration is dependent on a customer’s behavior (i.e. volume discount that increases based upon purchasing), then the ‘expected value method’ is the preferred method of estimation.
- Most likely amount – the most likely amount is the single most likely amount in a range of possible consideration amounts or the single most likely outcome. If the achievement of the variable discount is binary, and the customer is either going to receive the discount, rebate, or other form of variable consideration, or not, then the most likely amount will be the preferred method of estimation.
Estimates of variable consideration are subject to change as facts and circumstances evolve, and as such accounting departments should revise estimates of variable consideration at each determined reporting date throughout the contract period.
Knoxville, TN, Accountants Lawhorn CPA Group
At the inception of Revenue from Contracts with Customers, we worked diligently to prepare ourselves and in turn our clients for adopting these changes. As these take effect, we are here to support you along the way. An accounting professional is available to answer any questions and you can reach out via phone at 865-212-4867, online, or by emailing us.