The staff understands that this question has been raised by stakeholders, in part, because of interpretations of Example 22, Right of Return, in Topic 606. The example states that the entity is applying the portfolio practical expedient, but it is unclear from the example how the application of the portfolio practical expedient affects the accounting.

To address the implementation question, the staff analyzed Example 22. The following stated facts from the example are relevant to this implementation issue:

In this example, the entity selected the expected value method to estimate variable consideration because it would better predict the amount of consideration to which it will be entitled. The staff observes that there are two potential outcomes for each contract from the variability of product returns: the product either will be returned or will not be returned. That is, the revenue for each contract ultimately either will be $100 or will be $0. However, the entity concluded that the expected value is the appropriate method for estimating variable consideration, because the entity has a large number of contracts with similar characteristics. In order to estimate the expected value, the entity considers evidence from historical experience for this product and customer class and concludes that $97 is the expected value from each contract.

The example states that the entity applied the portfolio practical expedient in accordance with paragraph 606-10-10-4. The application of the portfolio practical expedient requires that the “entity reasonably expects that the effects on the financial statements of applying this guidance to the portfolio would not differ materially from applying this guidance to the individual contracts (or performance obligations) within that portfolio.” That is, when electing the portfolio practical expedient, the entity has concluded that there could be a difference in the accounting between the individual contract(s) and the portfolio of contracts. While the Board indicated that they did not intend for entities to “quantitatively evaluate each outcome,” in applying the portfolio practical expedient, there would be a difference that could be assessed.

The example states that the contracts relate to the sale of a single product; therefore, the products are homogenous in nature. There is nothing in the example to indicate that there could be a difference between estimating variable consideration for returns for the individual contracts using the expected value method or the portfolio of contracts. That is, there is no reason that the entity needed to elect the portfolio practical expedient.

In contrast, consider the following change to the example that could result in a difference between the accounting for the individual contracts and the portfolio of contracts: An entity enters into 100 contracts with customers. The 100 contracts are for 45 contracts for one unit of product A for $100 per unit and 55 contracts for one unit of product B for $100 per unit. Product A has a historical return rate of 4% and Product B has a historical return rate of 3%. However, the weighted-average return rate for Products A and B is about 3% because historically more of Product B has been sold than Product A.

Similar to the original example, the entity concludes that the expected value method best predicts the amount of consideration to which it will be entitled. In this case, the entity concludes that information about return rates for Product B are not relevant in estimating the return rate for Product A, and vice versa. To account for the individual contracts, the entity would make a separate estimate of variable consideration for Products A and B on the basis of its historical experience with returns for each product. The entity would recognize total revenue of $9,600, as follows (the return rate is applied to the number of products):

Alternatively, the entity could apply the portfolio practical expedient in paragraph 606-10-10-4 if it reasonably expects that the difference between accounting for each individual contract ($9,600 of total revenue) would not vary materially from accounting for the portfolio of contracts ($9,700 of total revenue, which is based on applying an overall 3% return rate). The quantification of the difference is provided to illustrate application of the portfolio practical expedient. Topic 606 does not require quantification; an entity is only required to conclude that there is a reasonable expectation that the effects on the financial statements from applying the guidance to a portfolio of contracts would not differ materially from applying this guidance to individual contracts within the portfolio.

The staff thinks that an entity can consider evidence from other, similar contracts to develop an estimate of variable consideration using the expected value method without applying the portfolio practical expedient. That is, the use of a portfolio of data is not the same as applying the portfolio practical expedient. In order to make an estimate of variable consideration in a contract (and other estimates to account for a contract with a customer), an entity frequently will make judgments, in part, based on its historical experience with other, similar contracts. Considering historical experience does not necessarily mean the entity is applying the portfolio practical expedient. The staff observes that this view is further made clear by the guidance on estimating the standalone selling price of a good or service. Paragraph 606-10-32-34(a) states that a suitable method for estimating the standalone selling price of a good or service would include referring to prices of similar goods or services.