Accounting: The Language of Business - Vol. 2 (Intermediate: Part 118)

“You don’t build a business, you build the people, then people build the business.”
— Zig Ziglar

Revenue Recognition (Part E)

by

Charles Lamson

Step 3: Determine the Transaction Price

Recall from Exhibit 8.1 from Part 114 and reintroduced below, the five steps in revenue recognition. The next few parts in this analysis will discuss Step 3.

The third step in the revenue recognition process is to determine the transaction price. The transaction price is the amount of consideration that the entity expects to be entitled to as a result of providing goods or services to the customer. The transaction price is not necessarily the price stated in the contract—rather, it is the amount the seller expects to receive. The transaction price does not include amounts collected that will be remitted to third parties (such as sales tax).

The transaction price is the amount that an entity will ultimately recognize as revenue. Measuring the transaction price can be quite simple in some cases. For example, assume a customer shopping at a retail store selects and pays $100 cash for a new dress. The transaction price is $100. However, with complex transactions, determining the transaction price is involved. Sellers consider the effects of a number of different factors when determining the transaction price, including:

1. Variable consideration and constraining estimates of variable consideration

2. Any significant financing component in the contract

3. Noncash consideration

4. Consideration payable to a customer

 We discuss each of these factors in the following sections.

Variable Consideration and Constraining Estimates of Variable Consideration

Variable consideration is when the payment received for providing a good or service is not a fixed amount. The amount of consideration may vary from a fixed amount due to price concessions, performance bonuses or penalties, discounts, refunds, rebates, and incentives. Elements of variable consideration may be stated explicitly or implicitly in the contract. For example, a discount for early payment typically offered by a seller is considered an element of variable consideration, even though it may not be specified explicitly in the contract.

If variable consideration is included in the contract, then the entity must estimate the consideration that it expects to receive using one of two acceptable approaches: the expected-value approach (discussed below) or the most-likely-amount approach (discussed in Part 119). The entity should use the approach that provides the best estimate of the amount of consideration it will receive.

Expected-Value Approach. To compute the expected transaction amount under the expected-value approach, the entity sums the probability-weighted amounts in a range of possible consideration amounts. This method is best suited when the entity has a large number of contracts with similar characteristics. This approach is Illustrated in Example 8.6. 

*GORDON, RAEDY, SANNELLA, 2019, INTERMEDIATE ACCOUNTING, 2ND ED., PP. 381-382*

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