Revenue Recognition Step 3: Determine the Transaction Price

137299508The third step of the new revenue recognition standard is to determine the transaction price,  which is the amount of consideration to which an entity expects to be entitled and includes:

  1. An estimate of any variable consideration (i.e. amounts that vary due to rebates or bonuses) using either a probability weighted expected value or the most likely amount, whichever better predicts the amount of consideration to which the entity will be entitled.
  2. The effect of the time value of money, if there is a financing component that is significant to the contract.
  3. The fair value of any non-cash consideration.
  4. The effect of any consideration payable to the customer, such as vouchers and coupons.

The transaction price is generally not adjusted for credit risk. However, the transaction price is constrained because of variable consideration. This means that the standard limits the amount of variable consideration to the amount for which it is probable that a subsequent change in estimated variable consideration will not result in a significant revenue reversal.

This is a change from current accounting for revenue, as accounting for variable consideration is inconsistent across industries. Under current guidance, an organization does not include variable amounts in the transaction until the variability is resolved. The new standards give a single model whereby variable consideration (e.g., rebates, discounts, bonuses, right of return) will be included in the transaction price to the extent it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur. This inclusion of variable consideration may accelerate the recognition of revenue compared to current standards.

Read other articles in our “Revenue Recognition” Series:

Hatch, MichelleMichelle Hatch is a partner in our Non-Profit Services Group. She oversees audit and accounting engagements for non-profit organizations, including independent schools, trade associations, health and human service organizations and art, cultural and membership organizations. Michelle is also a member of the Employee Benefit Assurance Group and oversees audits for 401(k), 403(b) and defined benefit retirement plans.

One comment

  1. Jordan says:

    Excellent overview of transaction prices. Even if you have someone else doing your accounting, it’s very important to learn basic information like this. It can help you understand what your accountant is doing for you.

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