Consider the following example:

To estimate the variable consideration in a new contract with a customer, Entity A considers paragraph 606-10-32-8 and concludes that the expected value method, as compared to the most likely amount method, would better predict the amount of consideration to which it will be entitled because the entity has a large number of contracts that have similar characteristics to the new contract. The expected value of the variable consideration is $65,000 ([$0 * 15%] + [$50,000 * 40%] + [$100,000 * 45%]). When considering the constraint on variable consideration, Entity A considered the factors that could increase the likelihood of a revenue reversal in paragraph 606-10-32-12 and concluded that it has relevant historical experience with similar types of contracts and that the amount of consideration is not highly susceptible to factors outside of the entity’s influence. There are two views regarding the appropriate amount of variable consideration to include in the transaction price:

A few TRG members thought that the transaction price must be a possible outcome in that specific contract (View A). However, most TRG members thought that the application of that view would not result in recognizing revenue in a manner that is consistent with the core principle of Topic 606. When an entity has concluded that the expected value approach is the appropriate method to estimate variable consideration, application of the constraint also is performed based on the expected value method (View B). That is, an entity is not required to switch from an expected value method to most likely amount for purposes of applying the constraint. As a result, if an entity applies the expected value method (and uses a portfolio of data in determining the expected value) for a particular contract, the estimated transaction price might not be a possible outcome in an individual contract. An entity must still consider the constraint on variable consideration. That is, in some cases, an entity might constrain an expected value estimate when determining the transaction price.

TRG members also raised a question about when an entity is required to use the expected value method versus the most likely amount method to estimate variable consideration. Paragraph 606-10-32-8 requires that an entity select the method that the “entity expects to better predict the amount of consideration to which it will be entitled.” The expected value method may better predict the amount of consideration to which the entity will be entitled if an entity has a large number of contracts with similar characteristics. The determination of which method to use in estimating variable consideration will require judgment.