Variable consideration under the new revenue standard (ASC 606)

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Video , PwC US Nov 29, 2017

Upon adoption of the new revenue standard, entities will need to consider the impact of variable consideration. This is a significant change from existing GAAP and will require entities to estimate the amount of consideration it is expected to receive. This estimate includes considering any constraints on the consideration. Matthew Albert discusses each of these topics and how to think through them upon adoption of ASC 606.

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Hi, I’m Matthew Albert, a Senior Manager in our National Office.

The new revenue standard requires an entity to estimate the amount of variable consideration to which it will be entitled. This is a significant change from existing GAAP which does not allow a company to recognize revenue until the contingency is resolved.

Today, we will discuss what can be considered to be variable consideration, the two estimation methods available, a constraint on the amount that can be recognized, and an exception for licenses of intellectual property.

To begin, let’s discuss what we mean by variable consideration. Variable consideration is defined broadly and can take many forms, such as price concessions, rebates or refunds. Consideration is also considered variable if the amount an entity will receive is contingent on a future event occurring or not occurring, even though the amount itself is fixed.

It is important to remember that variable consideration can result from explicit terms in a contract or can be implied by an entity's past business practices. For example, a company that has a business practice of accepting returns even though there is not an explicit return right. As a reminder, an estimate of variable consideration may either increase, or decrease, the contract transaction price.

Now, let’s turn the discussion to the accounting for variable consideration. When determining the total transaction price of an arrangement, management must include an estimate of any variable consideration using either - the “expected value” method or the “most likely amount” method.

The expected value method estimates variable consideration based on the range of possible outcomes and the probabilities of each outcome.

This method might be most appropriate when an entity has a large number of contracts that have similar characteristics. This is because an entity will likely have better information about the probabilities of various outcomes when there are a large number of similar transactions.

On the other hand, the most likely amount method estimates variable consideration based on the single most likely amount in a range of possible consideration amounts. This method might be the most predictive if the entity will receive one of only two possible amounts. This is because the expected value method could result in an amount of consideration that is not one of the possible outcomes.

The method used is not a policy choice and should be applied consistently throughout a contract. Management should use the method that it expects will best predict the amount of consideration to which the entity will be entitled based on the terms of each contract. Management’s estimate of variable consideration will need to be reassessed at each reporting date based on changes in facts and circumstances.

Let’s move on to discuss the constraint on variable consideration.

Specifically, an entity may only include variable consideration within the transaction price to the extent that it is probable that a significant reversal of revenue will not occur when the uncertainty is subsequently resolved. This assessment will require the application of judgment and entities should remember that the evaluation of significance should be performed at the contract level, and not the performance obligation level, or in relation to the financial position of the company.

While no single factor is determinative, the revenue standard includes factors to consider when assessing whether variable consideration should be constrained. The following factors may increase the likelihood or the magnitude of a revenue reversal:

  • First, the amount of consideration is highly susceptible to factors outside the entity’s influence, including volatility in a market or the actions of third parties.
  • Second, the uncertainty is not expected to be resolved for a long period of time
  • Third, the entity’s experience with similar types of contracts is limited, or that experience has limited predictive value
    Fourth, the entity has a practice of either offering a broad range of price concessions or changing the payment terms of similar contracts.
  • And finally, the contract has a broad range of possible consideration amounts.

When applying the constraint, entities should remember that they will need to include a minimum amount of variable consideration if they believe that amount is probable of not being reversed. Companies likely cannot default to assuming the transaction price is zero.

Finally, to touch on our final topic, companies should remember that the new standard includes an exception to the accounting for variable consideration relating to licenses of intellectual property with sales- or usage-based royalties. Revenue from royalties in the scope of the exception cannot be recognized until the related sales or usage occurs, even if such royalties could be estimated in advance.

In summary, the requirement under the new revenue standard to estimate variable consideration is a significant change from existing GAAP. This estimate will require the application of significant judgment. Companies should ensure that they have the appropriate controls in place around these key judgments.

For more information on this topic, refer to Chapter 4 of our Revenue accounting guide, available on

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