In step four of the revenue model, entities are required to allocate the transaction price to the performance obligations in the contract. The transaction price is generally allocated using the relative standalone selling price method. However, the standard includes two exceptions: allocating discounts and allocating variable consideration. This article explores the process of allocating variable consideration.
Deciding Whether the Exception Applies
In many instances, the expected consideration in a transaction is a variable amount, such as when an entity will get a bonus if it finishes the project ahead of schedule. In these instances, the variable consideration that an entity expects to receive must be estimated. Once the variable consideration has been estimated, the entity must determine if the consideration is attributable to:
- All of the performance obligations
- One or more, but not all, of the performance obligations (e.g., the consideration is based on the percentage of sales to customers that use a software license when the license is only one portion of the contract).
- One or more, but not all, distinct goods or services provided in a series of distinct goods or services that make up one performance obligation (e.g., the price for the second year of a two-year cleaning service contract will increase based on the movement of an inflation index) (see ASC 606-10-32-39).
The variable consideration is allocated to one or more, but not all, of the performance obligations or distinct goods or services if the following two criteria are met:
- The terms of the variable payment relate specifically to the entity’s efforts to satisfy the performance obligation or transfer the good or service (or to a specific outcome from satisfying the performance obligation or transferring the good or service).
- Allocating the variable amount of consideration entirely to the performance obligation or distinct good or service represents the amount of consideration that the entity would expect to receive for transferring the promised goods or services to the customer (see ASC 606-10-32-40).
If these two criteria are met, the entity is required to allocate the variable consideration to the related performance obligations or distinct goods or services. The following examples illustrate how to allocate variable consideration in the transaction price (see ASC 606-10-55-270 to 55-279).
After variable consideration has been estimated, an entity must allocate the variable consideration to the performance obligations. Usually, the consideration will be allocated to all performance obligations using the relative standalone selling price method. However, the standard provides two criteria to determine if the consideration should be attributed to one or more, but not all, of the performance obligations. If both of the criteria are met, the variable consideration must be allocated to the related performance obligations.
- ASC 606-10-32-39 to 32-41, 55-270 to 55-274, 55-275 to 55-279
- KPMG, Issues In-Depth: “Revenues from Contracts with Customers.” May 2016. Section 126.96.36.199.
- PwC: “Revenue from Contracts with Customers.” February 2022. Section 5.5.
- EY: “Financial Reporting Developments - Revenue from Contracts with Customers.” September 2022. Section 6.3.