Understanding Variable Consideration Under the New Revenue Standard

Private entities under the new revenue standard need to consider the impact of variable consideration. This significant change from prior GAAP guidance requires entities to evaluate certain factors to determine the amount of revenue to recognize.  Thus, it is now important to actively review your “transaction price” in that the contract price is impacted by the amount of variable consideration. 

The most common instances of variable consideration include:

  • Change orders (approved or unapproved)
  • Claims
  • Bonuses or incentives
  • Liquidating damages or penalties
  • A significant financing component (where performance doesn’t materially match the cash flow between the parties) 
  • Noncash consideration
  • Consideration payable to customers

When you have these items of variable consideration, you need to adjust your contract price (increase or decrease) to the extent of the variable consideration subject to the constraint guidance.  The guidance indicates you do not want to encounter a “significant reversal of revenue”.

There are two methods whereby you recognize variable consideration:

  • The most likely amount approach – “all or nothing”
    • If the performance obligation is met, you receive the incentive
    • If it is not met, you receive nothing
    • You can include the maximum amount based on prior judgment and experience
  • The expected value approach
    • You determine the expected range of values
    • Evaluate based on prior experience and judgment
    • Use a probability weighted calculation that has a probable chance of collection

This estimate may require the application of significant judgement. Companies should ensure they have the appropriate controls in place and understand how to implement them (link to implementation article on Variable consideration).  KatzAbosch has individuals experienced in contractor issues and trained in process improvement using lean six sigma principles that can help you through this transition. . If you have any questions about this information please contact your KatzAbosch representative; or contact us by clicking here.

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