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The revenue standard requires a reporting entity to estimate the amount of variable consideration to which it will be entitled.

ASC 606-10-32-5

If the consideration promised in a contract includes a variable amount, an entity shall estimate the amount of consideration to which the entity will be entitled in exchange for transferring the promised goods or services to a customer.

Variable consideration is common and takes various forms, including (but not limited to) price concessions, volume discounts, rebates, refunds, credits, incentives, performance bonuses, milestone payments, and royalties. A reporting entity's past business practices can cause consideration to be variable if there is a history of providing discounts or concessions after goods are sold.
Consideration is also variable if the amount a reporting entity will receive is contingent on a future event occurring or not occurring, even though the amount itself is fixed. This might be the case, for example, if a customer can return a product it has purchased. The amount of consideration the reporting entity is entitled to receive depends on whether the customer retains the product or not (refer to RR 8.2 for a discussion of return rights). Similarly, consideration might be contingent upon meeting certain performance goals or deadlines.
The amount of variable consideration included in the transaction price may be constrained in certain situations, as discussed at RR 4.3.2.
Question RR 4-1 addresses whether the consideration is variable if pricing is fixed but the quantity is variable.
Question RR 4-1
If a contract contains a promise to provide an unspecified quantity of outputs, but the contractual rate per unit is fixed, is the consideration variable?
PwC response
Generally, yes. An example is a promise to provide a service when the rate per hour is fixed, but the total number of hours that will be incurred to fulfill the promise is variable. Refer to Revenue TRG Memo No. 39 and the related meeting minutes in Revenue TRG Memo No. 44 for further discussion of this topic. Judgment may be required to distinguish between a promise with a variable fee and an arrangement permitting the customer to purchase a variable number of goods or services. Refer to RR 3.5 for further discussion of this distinction.

Question RR 4-2 addresses whether variable consideration must be estimated if it is allocated entirely to a wholly unsatisfied performance obligation or a distinct good or service in a series.
Question RR 4-2
If variable consideration meets the criteria in ASC 606-10-32-40 to be allocated entirely to a wholly unsatisfied performance obligation or a distinct good or service in a series, is it necessary to estimate the variable consideration at contract inception?
PwC response
It depends. It may not be necessary to estimate variable consideration at contract inception when the variable consideration is allocated entirely to a performance obligation to be satisfied in the future or a distinct good or service in a series. For example, a monthly usage-based fee in a three-year contract to provide a series of monthly services might meet the criteria to be allocated entirely to the month that the related usage occurs. In that case, it would likely not be necessary at contract inception to estimate the total of the monthly usage-based fees for the entire contract term. In other situations, management may need to estimate the variable consideration in order to evaluate the second criterion in ASC 606-10-32-40, which requires an assessment of whether the resulting allocation is consistent with the allocation objective in ASC 606-10-32-28 when considering all of the performance obligations in the contract. Refer to RR 5.5.1 for further discussion of allocating variable consideration.

4.3.1 Estimating variable consideration

The objective of determining the transaction price is to predict the amount of consideration to which the reporting entity will be entitled, including amounts that are variable. Management determines the total transaction price, including an estimate of any variable consideration, at contract inception and reassesses this estimate at each reporting date. Management should use all reasonably available information to make its estimate. Judgments made in assessing variable consideration should be disclosed, as discussed in FSP 33.4.
The revenue standard provides two methods for estimating variable consideration.

ASC 606-10-32-8

An entity shall estimate an amount of variable consideration by using either of the following methods, depending on which method the entity expects to better predict the amount of consideration to which it will be entitled:
a. The expected value—The expected value is the sum of probability-weighted amounts in a range of possible consideration amounts. An expected value may be an appropriate estimate of the amount of variable consideration if an entity has a large number of contracts with similar characteristics.
b. The most likely amount—The most likely amount is the single most likely amount in a range of possible consideration amounts (that is, the single most likely outcome of the contract). The most likely amount may be an appropriate estimate of the amount of variable consideration if the contract has only two possible outcomes (for example, an entity either achieves a performance bonus or does not).

The method used is not a policy choice. Management should use the method that it expects best predicts the amount of consideration to which the reporting entity will be entitled based on the terms of the contract. The method used should be applied consistently throughout the contract. However, a single contract can include more than one form of variable consideration. For example, a contract might include both a bonus for achieving a specified milestone and a bonus calculated based on the number of transactions processed. Management may need to use the most likely amount to estimate one bonus and the expected value method to estimate the other if the underlying characteristics of the variable consideration are different.

4.3.1.1 Expected value method

The expected value method estimates variable consideration based on the range of possible outcomes and the probabilities of each outcome. The estimate is the probability-weighted amount based on those ranges. The expected value method might be most appropriate where a reporting entity has a large number of contracts that have similar characteristics. This is because a reporting entity will likely have better information about the probabilities of various outcomes where there are a large number of similar transactions.
Management must, in theory, consider and quantify all possible outcomes when using the expected value method. However, considering all possible outcomes could be both costly and complex. A limited number of discrete outcomes and probabilities can provide a reasonable estimate of the distribution of possible outcomes in many cases.
A reporting entity considers evidence from other, similar contracts by using a “portfolio of data” to develop an estimate when it estimates variable consideration using the expected value method. This, however, is not the same as applying the optional portfolio practical expedient that permits reporting entities to apply the guidance to a portfolio of contracts with similar characteristics (refer to RR 1.2.2). Considering historical experience with similar transactions does not necessarily mean a reporting entity is applying the portfolio practical expedient. Refer to Revenue TRG Memo No. 38 and the related meeting minutes in Revenue TRG Memo No. 44 for further discussion of this topic.

4.3.1.2 Most likely amount method

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 reporting entity will receive one of only two (or a small number of) possible amounts. This is because the expected value method could result in an amount of consideration that is not one of the possible outcomes.

4.3.1.3 Examples of estimating variable consideration

Example RR 4-1 and Example RR 4-2 illustrate how the transaction price should be determined when there is variable consideration. This concept is also illustrated in Examples 20 and 21 of the revenue standard (ASC 606-10-55-194 through ASC 606-10-55-200).
EXAMPLE RR 4-1

Estimating variable consideration – performance bonus with multiple outcomes
Contractor enters into a contract with Widget Inc to build an asset for $100,000 with a performance bonus of $50,000 that will be paid based on the timing of completion. The amount of the performance bonus decreases by 10% per week for every week beyond the agreed-upon completion date. The contract requirements are similar to contracts Contractor has performed previously, and management believes that such experience is predictive for this contract. Contractor concludes that the expected value method is most predictive in this case.
Contractor estimates that there is a 60% probability that the contract will be completed by the agreed-upon completion date, a 30% probability that it will be completed one week late, and a 10% probability that it will be completed two weeks late.
How should Contractor determine the transaction price?
Analysis
The transaction price should include management's estimate of the amount of consideration to which the reporting entity will be entitled for the work performed.
Probability-weighted consideration
$150,000 (fixed fee plus full performance bonus) x 60%
$
90,000
$145,000 (fixed fee plus 90% of performance bonus) x 30%
$
43,500
$140,000 (fixed fee plus 80% of performance bonus) x 10%
$
14,000
Total probability-weighted consideration
$
147,500

The total transaction price is $147,500 based on the probability-weighted estimate. Contractor will update its estimate at each reporting date.
This example does not consider the potential need to constrain the estimate of variable consideration included in the transaction price. Depending on the facts and circumstances of each contract, a reporting entity might need to constrain its estimate of variable consideration even if it uses the expected value method to determine the transaction price. Refer to RR 4.3.2 for further discussion of application of the constraint on variable consideration.
EXAMPLE RR 4-2

Estimating variable consideration – performance bonus with two outcomes
Contractor enters into a contract to construct a manufacturing facility for Auto Manufacturer. The contract price is $250 million plus a $25 million award fee if the facility is completed by a specified date. The contract is expected to take three years to complete. Contractor has a long history of constructing similar facilities. The award fee is binary (that is, there are only two possible outcomes) and is payable in full upon completion of the facility. Contractor will receive none of the $25 million fee if the facility is not completed by the specified date.
Contractor believes, based on its experience, that it is 95% likely that the contract will be completed successfully and in advance of the target date.
How should Contractor determine the transaction price?
Analysis
It is appropriate for Contractor to use the most likely amount method to estimate the variable consideration. The contract's transaction price is therefore $275 million, which includes the fixed contract price of $250 million and the $25 million award fee. This estimate should be updated each reporting date.

4.3.2 Constraint on variable consideration

The revenue standard includes a constraint on the amount of variable consideration included in the transaction price as follows.

ASC 606-10-32-11

An entity shall include in the transaction price some or all of an amount of variable consideration…only to the extent that it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is subsequently resolved.

Determining the amount of variable consideration to record, including any minimum amounts as discussed in RR 4.3.2.7, requires judgment. The assessment of whether variable consideration should be constrained is largely a qualitative one that has two elements: the magnitude and the likelihood of a change in estimate. “Probable” is defined as “the future event or events are likely to occur,” which is generally considered a 75% threshold.
Variable consideration is not constrained if the potential reversal of cumulative revenue recognized is not significant. Significance should be assessed at the contract level (rather than the performance obligation level or in relation to the financial position of the reporting entity). Management should therefore consider revenue recognized to date from the entire contract when evaluating the significance of any potential reversal of revenue. Refer to Revenue TRG Memo No. 14 and the related meeting minutes in Revenue TRG Memo No. 25 for further discussion of this topic.
Management should consider not only the variable consideration in an arrangement, but also any fixed consideration to assess the possible significance of a reversal of cumulative revenue. This is because the constraint applies to the cumulative revenue recognized, not just to the variable portion of the consideration. For example, the consideration for a single contract could include both a variable and a fixed amount. Management needs to assess the significance of a potential reversal relating to the variable amount by comparing that possible reversal to the cumulative combined fixed and variable amounts.
The revenue standard provides factors to consider when assessing whether variable consideration should be constrained. All of the factors should be considered and no single factor is determinative. Judgment should be applied in each case to decide how best to estimate the transaction price and apply the constraint. In performing this assessment, a portfolio of data might be used to estimate the transaction price (refer to RR 4.3.1.1) and used to apply the constraint on variable consideration. In that case, the estimated transaction price might not be a possible outcome of the individual contract. Refer to Example RR 4-7 for an illustration of this fact pattern.

Excerpt from ASC 606-10-32-12

Factors that could increase the likelihood or the magnitude of a revenue reversal include, but are not limited to, any of the following:
a. The amount of consideration is highly susceptible to factors outside the entity's influence. Those factors may include volatility in a market, the judgment or actions of third parties, weather conditions, and a high risk of obsolescence of the promised good or service.
b. The uncertainty about the amount of consideration is not expected to be resolved for a long period of time.
c. The entity's experience (or other evidence) with similar types of contracts is limited, or that experience (or other evidence) has limited predictive value.
d. The entity has a practice of either offering a broad range of price concessions or changing the payment terms and conditions of similar contracts in similar circumstances.
e. The contract has a large number and broad range of possible consideration amounts.

4.3.2.1 Amount is highly susceptible to external factors

Factors outside a reporting entity’s influence can affect a reporting entity’s ability to estimate the amount of variable consideration. An example is consideration that is based on the movement of a market, such as the value of a fund whose assets are based on stock exchange prices.
Factors outside a reporting entity's influence could also include the judgment or actions of third parties, including customers. An example is an arrangement where consideration varies based on the customer's subsequent sales of a good or service. However, the reporting entity could have predictive information that enables it to conclude that variable consideration is not constrained in some scenarios.
The revenue standard also includes a narrow exception that applies only to licenses of intellectual property with consideration in the form of sales- and usage-based royalties. Revenue is recognized at the later of when (or as) the subsequent sale or usage occurs, or when the performance obligation to which some or all of the royalty has been allocated has been satisfied (or partially satisfied) as discussed in RR 4.3.5.

4.3.2.2 Uncertainty not expected to be resolved in the near term

A long period of time until the uncertainty is resolved might make it more challenging to determine a reasonable range of outcomes of that uncertainty, as other variables might be introduced over the period that affect the outcome. This makes it more difficult to assert that it is probable that a significant reversal of cumulative revenue recognized will not occur. Management might be able to more easily conclude that variable consideration is not constrained when an uncertainty is resolved in a short period of time.
Management should consider all facts and circumstances, however, as in some situations a longer period of time until the uncertainty is resolved could make it easier to conclude that a significant reversal of cumulative revenue will not occur. Consider, for example, a performance bonus that will be paid if a specific sales target is met by the end of a multi-year contract term. Depending on existing and historical sales levels, that target might be considered easier to achieve due to the long duration of the contract.

4.3.2.3 Experience is limited or of limited predictive value

A reporting entity with limited experience might not be able to predict the likelihood or magnitude of a revenue reversal if the estimate of variable consideration changes. A reporting entity that does not have its own experience with similar contracts might be able to rely on other evidence, such as similar contracts offered by competitors or other market information. However, management needs to assess whether this evidence is predictive of the outcome of the reporting entity's contract.

4.3.2.4 Reporting entity has a practice of changing pricing

A reporting entity might enter into a contract with stated terms that include a fixed price, but have a practice of subsequently providing price concessions or other price adjustments (including returns allowed beyond standard return limits). A consistent practice of offering price concessions or other adjustments that are narrow in range might provide the predictive experience necessary to estimate the amount of consideration. A reporting entity that offers a broad range of concessions or adjustments might find it more difficult to predict the likelihood or magnitude of a revenue reversal.

4.3.2.5 Contract has numerous or wide ranges of consideration

It might be difficult to determine whether some or all of the consideration should be constrained when a contract has a large number of possible outcomes that span a significant range. A contract that has more than one, but relatively few, possible outcomes might not result in variable consideration being constrained (even if the outcomes are significantly different) if management has experience with that type of contract. For example, a reporting entity that enters into a contract that includes a significant performance bonus with a binary outcome of either receiving the entire bonus if a milestone is met, or receiving no bonus if it is missed, might not need to constrain revenue if management has sufficient experience with this type of contract.

4.3.2.6 Examples of applying the constraint

Example RR 4-3, Example RR 4-4, Example RR 4-5, Example RR 4-6, and Example RR 4-7 illustrate the application of the constraint on variable consideration. This concept is also illustrated in Examples 23 and 25 of the revenue standard (ASC 606-10-55-208 through ASC 606-10-55-215  and ASC 606-10-55-221 through ASC 606-10-55-225).
EXAMPLE RR 4-3

Variable consideration – consideration is constrained
Land Owner sells land to Developer for $1 million. Land Owner is also entitled to receive 5% of any future sales price of the developed land in excess of $5 million. Land Owner determines that its experience with similar contracts is of little predictive value because the future performance of the real estate market will cause the amount of variable consideration to be highly susceptible to factors outside of the reporting entity’s influence. Additionally, the uncertainty is not expected to be resolved in a short period of time because Developer does not have current plans to sell the land.
Should Land Owner include variable consideration in the transaction price?
Analysis
No amount of variable consideration should be included in the transaction price. It is not probable that a significant reversal of cumulative revenue recognized will not occur resulting from a change in estimate of the consideration Land Owner will receive upon future sale of the land. The transaction price at contract inception is therefore $1 million. Land Owner will update its estimate, including application of the constraint, at each reporting date until the uncertainty is resolved. This includes considering whether any minimum amount should be recorded.
EXAMPLE RR 4-4

Variable consideration – subsequent reassessment
Land Owner sells land to Developer for $1 million. Land Owner is also entitled to receive 5% of any future sales price of the developed land in excess of $5 million. Land Owner determines that its experience with similar contracts is of little predictive value, because the future performance of the real estate market will cause the amount of variable consideration to be highly susceptible to factors outside of the reporting entity’s influence. Additionally, the uncertainty is not expected to be resolved in a short period of time because Developer does not have current plans to sell the land.
Two years after contract inception:
• Land prices have significantly appreciated in the market
• Land Owner estimates that it is probable that a significant reversal of cumulative revenue recognized will not occur related to $100,000 of variable consideration based on sales of comparable land in the area
• Developer is actively marketing the land for sale
How should Land Owner account for the change in circumstances?
Analysis
Land Owner should adjust the transaction price to include $100,000 of variable consideration for which it is probable a significant reversal of cumulative revenue recognized will not occur. Land Owner will update its estimate, either upward or downward, at each reporting date until the uncertainty is resolved.
EXAMPLE RR 4-5

Variable consideration – multiple forms of variable consideration
Construction Inc. contracts to build a production facility for Manufacturer for $10 million. The arrangement includes two performance bonuses as follows:
• Bonus A: $2 million if the facility is completed within six months
• Bonus B: $1 million if the facility receives a stipulated environmental certification upon completion
Construction Inc. believes that the facility will take at least eight months to complete but that it is probable it will receive the environmental certification, as it has received the required certification on other similar projects.
How should Construction Inc. determine the transaction price?
Analysis
The transaction price is $11 million. Construction Inc. should assess each form of variable consideration separately. Bonus A is not included in the transaction price as Construction Inc. does not believe it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur. Bonus B should be included in the transaction price as Construction Inc. has concluded it is probable based on the most likely outcome, that a significant reversal in the amount of cumulative revenue recognized will not occur. Construction Inc. will update its estimate at each reporting date until the uncertainty is resolved.
EXAMPLE RR 4-6

Variable consideration — milestone payments
Biotech licenses a drug compound that is currently in Phase II development to Pharma. Biotech also performs clinical trial services as part of the arrangement. In addition to an upfront payment, Biotech is eligible to receive additional consideration in the form of milestone payments as follows:
• Milestone A: $25 million upon the completion of Phase II clinical trials
• Milestone B: $50 million upon regulatory approval of the drug compound
Biotech has concluded it is probable that it will achieve Milestone A because Biotech has extensive experience performing clinical trial services in similar arrangements and the drug compound has successfully completed Phase I clinical trials. There are significant uncertainties related to achieving regulatory approval of the drug compound, which is subject to the judgments and actions of a third party. Biotech has concluded the milestone payments are outside the scope of guidance for financial instruments.
How should Biotech determine the transaction price?
Analysis
Both milestone payments are forms of variable consideration. The $25 million payable upon achieving Milestone A should be included in the transaction price because it is probable that a significant reversal of cumulative revenue recognized will not occur in the future when the uncertainty relating to Milestone A is subsequently resolved.
Biotech would likely conclude that the $50 million payable upon achieving Milestone B is constrained. The current stage of development of the drug compound, uncertainties related to obtaining approval, and the fact that regulatory approval is subject to factors outside Biotech’s influence would support this conclusion. Therefore, Biotech would exclude the $50 million payable upon achieving Milestone B from the transaction price at contract inception.
Biotech will need to update its estimates for both milestones at each reporting date until the uncertainty associated with each milestone is resolved.
EXAMPLE RR 4-7

Variable consideration — expected value method and applying the constraint
Entity L is a law firm that offers various legal services to its customers. For some services (“Specific Services”), Entity L will only collect payment from its customer if the customer wins the case. The payment for Entity L in each case is $1,000. Management has determined that revenue for these services should be recognized over time.
Entity L has a group of 1,000 similar contracts on homogeneous cases that include Specific Services. Management’s experience with contracts with similar characteristics to this group over the last five years is that 60% of Entity L’s customers won their cases, and success rates varied between 50% and 70% on a monthly basis throughout the period. Management has used this data to conclude that it is probable that it would collect payment in 50% of cases.
Management believes that the expected value approach provides a better prediction of the transaction price than the most likely amount.
How should Entity L determine the transaction price?
Analysis
Management of Entity L can use the data from previous contracts to estimate the transaction price and to apply the constraint on variable consideration. Management therefore would include $500,000 (equating to $500 per contract) of the variable consideration in the transaction price. The evidence provided by its experience with previous transactions would support its conclusion that it is probable that there would not be a significant revenue reversal if $500 is estimated as the transaction price for each contract. In making this assessment, management will have applied a consistent approach in estimating the transaction price and applying the constraint of variable consideration guidance.

4.3.2.7 Recording minimum amounts

The constraint could apply to a portion, but not all, of an estimate of variable consideration. A reporting entity needs to include a minimum amount of variable consideration in the transaction price if management believes that amount is not constrained, even if other portions are constrained. The minimum amount is the amount for which it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty is resolved.
Management may need to include a minimum amount in the transaction price even when there is no minimum threshold stated in the contract. Even when a minimum amount is stated in a contract, there may be an amount of variable consideration in excess of that minimum for which it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur if estimates change.
Example RR 4-8 illustrates the inclusion of a minimum amount of variable consideration in the transaction price.
EXAMPLE RR 4-8

Variable consideration – determining a minimum amount
Service Inc contracts with Manufacture Co to refurbish Manufacture Co's heating, ventilation, and air conditioning (HVAC) system. Manufacture Co pays Service Inc fixed consideration of $200,000 plus an additional $5,000 for every 10% reduction in annual costs during the first year following the refurbishment.
Service Inc estimates that it will be able to reduce Manufacture Co's costs by 20%. Service Inc, however, considers the constraint on variable consideration and concludes that it is probable that estimating a 10% reduction in costs will not result in a significant reversal of cumulative revenue recognized. This assessment is based on Service Inc's experience achieving at least that level of cost reduction in comparable contracts. Service Inc has achieved levels of 20% or above, but not consistently.
How should Service Inc determine the transaction price?
Analysis
The transaction price at contract inception is $205,000, calculated as the fixed consideration of $200,000 plus the estimated minimum variable consideration of $5,000 that will be received for a 10% reduction in customer costs. Service Inc will update its estimate at each reporting date until the uncertainty is resolved.

4.3.3 Common forms of variable consideration

Variable consideration is included in contracts with customers in a number of different forms. The following are examples of types of variable consideration commonly found in customer arrangements.

4.3.3.1 Price concessions

Price concessions are adjustments to the amount charged to a customer that are typically made outside of the initial contract terms. Price concessions are provided for a variety of reasons. For example, a vendor may accept a payment less than the amount contractually due from a customer to encourage the customer to pay for previous purchases and continue making future purchases. Price concessions are also sometimes provided when a customer has experienced some level of dissatisfaction with the good or service (other than items covered by warranty).
Management should assess the likelihood of offering price concessions to customers when determining the transaction price. A reporting entity that expects to provide a price concession, or has a practice of doing so, should reduce the transaction price to reflect the consideration to which it expects to be entitled after the concession is provided.
Example RR 4-9 illustrates the effect of a price concession.
EXAMPLE RR 4-9

Variable consideration – price concessions
Machine Co sells a piece of machinery to Customer for $2 million payable in 90 days. Machine Co is aware at contract inception that Customer may not pay the full contract price. Machine Co estimates that Customer will pay at least $1.75 million, which is sufficient to cover Machine Co's cost of sales ($1.5 million), and which Machine Co is willing to accept because it wants to grow its presence in this market. Machine Co has granted similar price concessions in comparable contracts.
Machine Co concludes it is probable it will collect $1.75 million, and such amount is not constrained under the variable consideration guidance.
What is the transaction price in this arrangement?
Analysis
Machine Co is likely to provide a price concession and accept an amount less than $2 million in exchange for the machinery. The consideration is therefore variable. The transaction price in this arrangement is $1.75 million, as this is the amount to which Machine Co expects to be entitled after providing the concession and it is not constrained under the variable consideration guidance. Machine Co can also conclude that the collectibility threshold is met for the $1.75 million and therefore, a contract exists, as discussed in RR 2.

4.3.3.2 Prompt payment discounts

Customer purchase arrangements frequently include a discount for early payment. For example, a reporting entity might offer a 2% discount if an invoice is paid within 10 days of receipt. A portion of the consideration is variable in this situation as there is uncertainty as to whether the customer will pay the invoice within the discount period. Management needs to make an estimate of the consideration it expects to be entitled to as a result of offering this incentive. Experience with similar customers and similar transactions should be considered in determining the number of customers that are expected to receive the discount.

4.3.3.3 Volume discounts

Contracts with customers often include volume discounts that are offered as an incentive to encourage additional purchases and customer loyalty. Volume discounts typically require a customer to purchase a specified amount of goods or services, after which the price is either reduced prospectively for additional goods or services purchased in the future or retroactively reduced for all purchases. Prospective volume discounts should be assessed to determine if they provide the customer with a material right, as discussed in RR 7.2.3. Arrangements with retroactive volume discounts include variable consideration because the transaction price for current purchases is not known until the uncertainty of whether the customer’s purchases will exceed the amount required to obtain the discount is resolved. Both prospective and retrospective volume discounts will typically result in a deferral of revenue if the customer is expected to obtain the discount.
Management also needs to consider the constraint on variable consideration for retroactive volume discounts. Management should include at least the minimum price per unit in the estimated transaction price at contract inception if it does not have the ability to estimate the total units expected to be sold. Including the minimum price per unit meets the objective of the constraint as it is probable that a significant reversal in the cumulative amount of revenue recognized will not occur. Management should also consider whether amounts above the minimum price per unit are constrained, or should be included in the transaction price. Management will need to update its estimate of the total sales volume at each reporting date until the uncertainty is resolved.
Example RR 4-10 and Example RR 4-11 illustrate how volume discounts affect transaction price. This concept is also illustrated in Example 24 of the revenue standard (ASC 606-10-55-216 through ASC 606-10-55-220).
EXAMPLE RR 4-10

Variable consideration – volume discounts
On January 1, 20X1, Chemical Co enters into a one-year contract with Municipality to deliver water treatment chemicals. The contract stipulates that the price per container will be adjusted retroactively once Municipality reaches certain sales volumes, defined as follows:
Price per container
Cumulative sales volume
$100
0–1,000,000 containers
$90
1,000,001–3,000,000 containers
$85
3,000,001 containers and above
Volume is determined based on sales during the calendar year. There are no minimum purchase requirements. Chemical Co estimates that the total sales volume for the year will be 2.8 million containers based on its experience with similar contracts and forecasted sales to Municipality.
Chemical Co sells 700,000 containers to Municipality during the first quarter ended March 31, 20X1 for a contract price of $100 per container.
How should Chemical Co determine the transaction price?
Analysis
The transaction price is $90 per container based on Chemical Co’s estimate of total sales volume for the year, since the estimated cumulative sales volume of 2.8 million containers would result in a price per container of $90.
Chemical Co concludes that, based on a transaction price of $90 per container, it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty is resolved. Revenue is therefore recognized at a selling price of $90 per container as each container is sold. Chemical Co will recognize a liability for cash received in excess of the transaction price for the first one million containers sold at $100 per container (that is, $10 per container) until the cumulative sales volume is reached for the next pricing tier and the price is retroactively reduced.
For the quarter ended March 31, 20X1, Chemical Co recognizes revenue of $63 million (700,000 containers * $90) and a liability of $7 million (700,000 containers * ($100 – $90)).
Chemical Co will update its estimate of the total sales volume at each reporting date until the uncertainty is resolved.
EXAMPLE RR 4-11

Variable consideration – reassessment of estimated volume discounts
On January 1, 20X1, Chemical Co enters into a one-year contract with Municipality to deliver water treatment chemicals. The contract stipulates that the price per container will be adjusted retroactively once Municipality reaches certain sales volumes, defined as follows:
Price per container
Cumulative sales volume
$100
0-1,000,000 containers
$90
1,000,001-3,000,000 containers
$85
3,000,001 containers and above
Volume is determined based on sales during the calendar year. There are no minimum purchase requirements. Chemical Co estimates that the total sales volume for the year will be 2.8 million containers based on its experience with similar contracts and forecasted sales to Municipality.
The following occurs in the first and second quarters of the year:
•  Chemical Co sells 700,000 containers to Municipality during the first quarter ended March 31, 20X1 for a contract price of $100 per container.
• Chemical Co sells 800,000 containers of chemicals during the second reporting period ended June 30, 20X1.
• Municipality commences a new water treatment project during the second quarter of the year, which increased its need for chemical supplies.
• In light of this new project, Chemical Co increases its estimate of total sales volume to 3.1 million containers at the end of the second reporting period. As a result, Chemical Co will be required to retroactively reduce the price per container to $85.
How should Chemical Co account for the change in estimate?
Analysis
Chemical Co should update its calculation of the transaction price to reflect the change in estimate. The updated transaction price is $85 per container based on the new estimate of total sales volume. Consequently, Chemical Co recognizes revenue of $64.5 million for the quarter ended June 30, 20X1, calculated as follows:
Total consideration
$85 per container * 800,000 containers sold in Q2
$
68,000,000
Less: $5 per container ($90-$85) * 700,000 containers sold in Q1
$
(3,500,000)
$
64,500,000
The cumulative catch-up adjustment reflects the amount of revenue that Chemical Co would have recognized if, at contract inception, it had the information that is now available.
Chemical Co will continue to update its estimate of the total sales volume at each reporting date until the uncertainty is resolved.

4.3.3.4 Rebates

Rebates are a widely used type of sales incentive. Customers typically pay full price for goods or services at contract inception and then receive a cash rebate in the future. This cash rebate is often tied to an aggregate level of purchases. Management needs to consider the volume of expected sales and expected rebates in such cases to determine the revenue to be recognized on each sale. The consideration is variable in these situations because it is based on the volume of eligible transactions.
Rebates are also often provided based on a single consumer transaction, such as a rebate on the purchase of a kitchen appliance if the customer submits a request for rebate to the seller. The uncertainty surrounding the number of customers that will fail to take advantage of the offer (often referred to as “breakage”) causes the consideration for the sale of the appliance to be variable.
Management may be able to estimate expected rebates if the reporting entity has a history of providing similar rebates on similar products. It could be difficult to estimate expected rebates in other circumstances, such as when the rebate is a new program, it is offered to a new customer or class of customers, or it is related to a new product line. It may be possible, however, to obtain marketplace information for similar transactions that could be sufficiently robust to be considered predictive and therefore used by management in making its estimate.
Management needs to estimate the amount of rebates to determine the transaction price. It should include amounts in the transaction price for arrangements with rebates only if it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur if estimates of rebates change. When management cannot reasonably estimate the amount of rebates that customers are expected to earn, it still needs to consider whether there is a minimum amount of variable consideration that should not be constrained.
Management should update its estimate at each reporting date as additional information becomes available.
Example RR 4-12 illustrates how customer rebates affect the transaction price.
EXAMPLE RR 4-12

Variable consideration – customer rebates
ShaveCo sells electric razors to retailers for $50 per unit. A rebate coupon is included inside the electric razor package that can be redeemed by the end consumers for $10 per unit.
ShaveCo estimates that 20% to 25% of eligible rebates will be redeemed based on its experience with similar programs and rebate redemption rates available in the marketplace for similar programs. ShaveCo concludes that the transaction price should incorporate an assumption of 25% rebate redemption as this is the amount for which it is probable that a significant reversal of cumulative revenue will not occur if estimates of the rebates change.
How should ShaveCo determine the transaction price?
Analysis
ShaveCo records sales to the retailer at a transaction price of $47.50 ($50 less 25% x $10). The difference between the per unit cash selling price to the retailers and the transaction price is recorded as a liability for cash consideration expected to be paid to the end customer. Refer to RR 4.6 for further discussion of consideration payable to a customer. ShaveCo will update its estimate of the rebate and the transaction price at each reporting date if estimates of redemption rates change.

4.3.3.5 Pricing based on an index or market

Consideration that is calculated based on an index or market price at a specified future date could be a form of variable consideration. Contract consideration could be linked to indices such as a consumer price index or financial indices (for example, the S&P 500), or the market price of a financial instrument or commodity.
Management should first consider whether the arrangement contains a derivative that should be accounted for under the relevant financial instruments guidance (for example, an arrangement with an embedded derivative that should be separately accounted for under ASC 815). Management should also consider whether to apply the financial instruments guidance when the reporting entity has satisfied its performance obligation and recorded a financial asset, but the amount of consideration continues to be linked to a future market price (for example, a provisionally priced commodity contract). Variability in pricing or value that is accounted for under the relevant financial instruments guidance does not affect measurement of the transaction price under the revenue standard (that is, the amount of revenue recognized).
For arrangements that are determined to include variable consideration based on an index or market price (in the scope of ASC 606), applying the constraint (refer to RR 4.3.2) will require judgment. Arrangements with fees that vary based on market or asset performance are common in the asset management and broker-dealer industries. One or more of the factors indicating that variable consideration should be constrained are often present in these arrangements. Specifically, the consideration is likely to be highly susceptible to factors outside the reporting entity’s influence (for example, market volatility or the length of time an investor remains invested in a fund), past experience may have limited predictive value, the contract may have a broad range of possible consideration amounts, and the uncertainty may not be resolved for a long period of time. The existence of these factors will likely indicate that all or a portion of the fees should be constrained until the uncertainty is resolved. This concept is illustrated in Example 25 of the revenue standard (ASC 606-10-55-221 through ASC 606-10-55-225).
Question RR 4-3 addresses whether the constraint applies to foreign currency exchange rate fluctuations.
Question RR 4-3
Does a reporting entity need to consider the variability caused by fluctuations in foreign currency exchange rates in applying the variable consideration constraint?
PwC response
No. Exchange rate fluctuations do not result in variable consideration as the variability relates to the form of the consideration (that is, the currency) and not other factors. Therefore, changes in foreign currency exchange rates should not be considered for purposes of applying the constraint on variable consideration.

4.3.3.6 Pricing based on a formula

A contract could include variable consideration if the pricing is based on a formula or a contractual rate per unit of outputs and there is an undefined quantity of outputs. The transaction price is variable because it is based on an unknown number of outputs. For example, a hotel management company enters into an arrangement to manage properties on behalf of a customer for a five-year period. Contract consideration is based on a defined percentage of daily receipts. The consideration is variable for this contract as it will be calculated based on daily receipts. The promise to the customer is to provide management services for the term of the contract; therefore, the contract contains a variable fee as opposed to an option to make future purchases. Refer to RR 3.5 for further discussion on assessing whether a contract contains variable fees or optional purchases. Refer also to Revenue TRG Memo No. 39 and the related meeting minutes in Revenue TRG Memo No. 44 for further discussion of this topic.

4.3.3.7 Periods after a contract expires but prior to renewal

Situations can arise where a reporting entity continues to perform under the terms of a contract with a customer that has expired while it negotiates an extension or renewal of that contract. The contract extension or renewal could include changes to pricing or other terms, which are frequently retroactive to the period after expiration of the original contract but prior to finalizing negotiations of the new contract. Judgment is needed to determine whether the parties' obligations are enforceable prior to signing an extension or renewal and, if so, the amount of revenue that should be recorded during this period. Refer to an assessment of whether a contract exists in Example RR 2-4 of RR 2.
Management will need to estimate the transaction price if it concludes that there are enforceable obligations prior to finalizing the new contract. Management should consider the potential terms of the renewal, including whether any adjustments to terms will be applied retroactively or only prospectively. Anticipated adjustments as a result of renegotiated terms should be assessed under the variable consideration guidance, including the constraint on variable consideration.
This situation differs from contract modifications where the transaction price is not expected to be variable at the inception of the arrangement, but instead changes because of a future event. Refer to RR 2.9 for discussion of contract modifications.

4.3.3.8 Price protection and price matching

Price protection clauses, sometimes referred to as “most favored nation” clauses, allow a customer to obtain a refund if the seller lowers the product's price to any other customers during a specified period. Price protection clauses ensure that the customer is not charged more by the seller than any other customer during this period. Price matching provisions require a reporting entity to refund a portion of the transaction price if a competitor lowers its price on a similar product. Both of these provisions introduce variable consideration into an arrangement as there is a possibility of subsequent adjustments to the stated transaction price.
Example RR 4-13 illustrates how price protection clauses affect the transaction price.
EXAMPLE RR 4-13

Variable consideration – price protection guarantee
Manufacturer enters into a contract to sell goods to Retailer for $1,000. Manufacturer also offers price protection where it will reimburse Retailer for any difference between the sale price and the lowest price offered to any customer during the following six months. This clause is consistent with other price protection clauses offered in the past, and Manufacturer believes it has experience that is predictive for this contract.
Management expects that it will offer a price decrease of 5% during the price protection period. Management concludes it is probable that a significant reversal of cumulative revenue will not occur if estimates change.
How should Manufacturer determine the transaction price?
Analysis
The transaction price is $950, as the expected reimbursement is $50. The expected payment to Retailer is reflected in the transaction price at contract inception as that is the amount of consideration to which Manufacturer expects to be entitled after the price protection. Manufacturer will recognize a liability for the difference between the invoice price and the transaction price, as this represents the cash it expects to refund to Retailer. Manufacturer will update its estimate of expected reimbursement at each reporting date until the uncertainty is resolved.
Some arrangements allow for price protection only on the goods that remain in a customer's inventory. Management needs to estimate the number of units to which the price protection guarantee applies in such cases to determine the transaction price, as the reimbursement does not apply to units already sold by the customer.

4.3.3.9 Guarantees (including service level agreements)

Contracts with a customer sometimes include guarantees made by the vendor. Guarantees in the scope of other guidance, such as ASC 460, Guarantees, should be accounted for following that guidance. Guarantees that are not in the scope of other guidance should be assessed to determine whether they result in a variable transaction price.
For example, a reporting entity might guarantee a customer that is a reseller a minimum margin on sales to its customers. Consideration will be paid to the customer if the specified margin is not achieved. This type of guarantee is not within the scope of ASC 460 as it constitutes a vendor rebate based on the guaranteed party’s sales (and thus meets the scope exception in ASC 460-10-15-7(e)). Since the guarantee does not fall within the scope of other guidance, the variable consideration guidance in the revenue standard needs to be considered in this situation given the uncertainty in the transaction price created by the guarantee.
Service level agreements (SLAs) are a form of guarantee frequently found in contracts with customers. SLA is a generic description often used to describe promises by a seller that include a guarantee of a product’s or service’s performance or a guarantee of warranty service response rates. SLAs are commonly used by companies that sell products or services that are critical to the customer's operations, where the customer cannot afford to have product failures, service outages, or service interruptions. For example, a vendor might guarantee a certain level of “uptime” for a network (for example, 99.999%) or guarantee that service call response times will be below a maximum time limit. SLAs might also include penalty clauses (liquidated damages) triggered by breach of the guarantees.
The terms and conditions of the SLA determine the accounting model. SLAs that are warranties should be accounted for under the warranty guidance discussed in RR 8. For example, an SLA requiring a reporting entity to repair equipment to restore it to original specified production levels could be a warranty. SLAs that are not warranties and could result in payments to a customer are variable consideration.
Example RR 4-14 and Example RR 4-15 illustrate the accounting for a guaranteed profit margin and a service level agreement.
EXAMPLE RR 4-14

Variable consideration – profit margin guarantee
ClothesCo sells a line of summer clothing to Department Store for $1 million. ClothesCo has a practice of providing refunds of a portion of its sales prices at the end of each season to ensure its department store customers meet minimum sales margins. Based on its experience, ClothesCo refunds on average approximately 10% of the invoiced amount. ClothesCo has also concluded that variable consideration is not constrained in these circumstances.
What is the transaction price in this arrangement?
Analysis
ClothesCo's practice of guaranteeing a minimum margin for its customers results in variable consideration. The transaction price in this arrangement is $900,000, calculated as the amount ClothesCo bills Department Store ($1 million) less the estimated refund to provide the Department Store its minimum margin ($100,000). ClothesCo will update its estimate at each reporting period until the uncertainty is resolved.
EXAMPLE RR 4-15

Variable consideration — service level agreement
SoftwareCo enters into a one-year contract with Customer A to provide access to its Software-as-a-Service (SaaS) platform for a $1 million annual fee. Included in the contract is a guarantee that the SaaS platform will maintain a 99.99% uptime during the year, or Customer A will be entitled to a partial refund of the annual fee. Based on its experience, SoftwareCo refunds on average approximately 5% of the annual fee under this guarantee. SoftwareCo has also concluded that variable consideration is not constrained in these circumstances.
What is the transaction price in this arrangement?
Analysis
The platform availability guarantee results in variable consideration. The transaction price in this arrangement is $950,000 ($1 million annual fee less 5% estimated refund). SoftwareCo will need to update its estimate of the refund at each reporting date until the uncertainty is resolved.

4.3.3.10 Claims

It is common for reporting entities in certain industries, such as engineering and construction, to submit claims to their customers for additional contract consideration if the scope of the contract changes. Claims that are enforceable under the existing terms of the contract, but for which the price is not yet determined, are accounted for as variable consideration. For example, a reporting entity might submit a claim as a result of higher-than-expected costs and interpret the contract to provide clear grounds for recovery of cost overruns. Thus, the estimated amount that the reporting entity will collect is included in the transaction price if it is probable that a significant reversal of cumulative revenue will not occur when the uncertainty is resolved.
In contrast, if the parties are negotiating a modification to a contract and the change in scope and/or price is not yet enforceable, the modification should not be accounted for until it is approved, as discussed in RR 2.9.1.
Example RR 4-16 illustrates the accounting for a claim. This concept is also illustrated in Example 9 of the revenue standard (ASC 606-10-55-134 through ASC 606-10-55-135).
EXAMPLE RR 4-16

Variable consideration – claims for additional cost reimbursement
Contractor enters into a contract for a satellite launch for Entity A. The contract price is $250 million and the contract is expected to take three years to complete. Contractor determines that the performance obligation will be satisfied over time. One year after contract inception, Contractor incurs significant costs in excess of the original estimates due to customer-caused delays. Contractor submits a claim against Entity A to recover a portion of the overrun costs. The claims process is in its early stages, but Contractor concludes that the claim is enforceable under the contract.
How should Contractor account for the claim?
Analysis
Contractor should update the transaction price based on its conclusion that it has an enforceable right to the claim. The claim amount is variable consideration and therefore, Contractor should include in the transaction price the estimated amount it will receive, adjusted for any amounts that are constrained under the variable consideration guidance. When applying the variable consideration constraint, Contractor should evaluate factors such as its relevant experience with similar claims and the period of time before resolution of the claim, in addition to whether the amount it will receive is highly susceptible to factors outside of its influence.

4.3.3.11 Penalties and liquidated damages

Terms that provide for cash payments to the customer for failure to comply with the terms of the contract or failure to meet agreed-upon specifications (for example, penalties and liquidated damages) should generally be accounted for as variable consideration. These terms differ from a warranty provision that requires a vendor to repair or replace a product that does not function as expected. Refer to RR 8.3 for further discussion of warranty provisions.

4.3.4 Changes in the estimate of variable consideration

Estimates of variable consideration are subject to change as facts and circumstances evolve. Management should revise its estimates of variable consideration at each reporting date throughout the contract period. Any changes in the transaction price are allocated to all performance obligations in the contract unless the variable consideration relates only to one or more, but not all, of the performance obligations. Refer to RR 5.5 for further discussion of allocating variable consideration.

4.3.5 Royalties received in exchange for licenses of IP

The revenue standard includes an exception for the recognition of revenue relating to licenses of IP with sales- or usage-based royalties. Revenue is recognized at the later of when (or as) the subsequent sale or usage occurs, or when the performance obligation to which some or all of the royalty has been allocated has been satisfied (or partially satisfied). Refer to RR 9 for additional information on the accounting for revenue from licenses of IP.
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