An entity offers a customer a volume rebate that depends on total purchases over a year, creating variable consideration under ASC 606. Under ASC 606-10-32-8, which factor determines whether the entity should estimate this variable consideration using the expected value method or the most likely amount method?
- Whichever method the entity expects to better predict the amount of consideration to which it will be entitled, considering factors such as whether the contract has many similar possible outcomes or only two possible outcomes
- The expected value method must always be used for rebates, regardless of the number of possible outcomes
- The most likely amount method must always be used whenever any variable consideration exists, regardless of the range of possible outcomes
- The choice is made by the customer, since the customer bears the risk of the rebate amount
Correct answer: A. Whichever method the entity expects to better predict the amount of consideration to which it will be entitled, considering factors such as whether the contract has many similar possible outcomes or only two possible outcomes
ASC 606-10-32-8 does not mandate a single method for every variable-consideration arrangement; instead it directs an entity to use whichever of the two methods it expects will better predict the consideration it is entitled to, and it further explains that the expected value (a probability-weighted sum of possible amounts) tends to work best when a contract has a large number of similar outcomes, while the most likely amount tends to work best when a contract has only two possible outcomes, such as achieving or not achieving a bonus. Because the method is chosen based on predictive suitability rather than transaction type, the option requiring expected value for every rebate and the option requiring most likely amount for every variable arrangement are both wrong, as each ignores the standard's judgment-based test. The customer has no role in selecting the entity's estimation method, since this is an internal accounting judgment made by the reporting entity, not a contractual term negotiated with the counterparty.
Source: FASB Accounting Standards Codification: ASC 606-10-32-8, Revenue from Contracts with Customers — Estimating Variable Consideration