An entity licenses software and is entitled to an additional bonus payment if the customer renews the license within 90 days, but the entity has very limited history with this type of bonus arrangement and renewal outcomes have historically been highly volatile for similar arrangements. Under ASC 606-10-32-11, how should the entity treat the estimated bonus when determining the transaction price?
- Include the estimated bonus in the transaction price only to the extent it is probable that a significant reversal of cumulative revenue will not occur when the uncertainty is resolved
- Always include the full estimated bonus amount in the transaction price regardless of the entity's confidence in the estimate
- Always exclude any variable consideration entirely until it is contractually guaranteed and no longer contingent on any future event
- Recognize the bonus as revenue only after cash is actually received, since variable consideration can never be estimated in advance
Correct answer: A. Include the estimated bonus in the transaction price only to the extent it is probable that a significant reversal of cumulative revenue will not occur when the uncertainty is resolved
ASC 606-10-32-11 constrains estimates of variable consideration so that an entity includes in the transaction price only the amount for which it is probable a significant revenue reversal will not occur in the future, and given the limited history and historically volatile outcomes described, the entity would need to constrain its estimate accordingly rather than include the full amount. Including the entire estimated bonus without regard to this probability assessment ignores the constraint the standard specifically imposes on volatile or poorly predictable variable amounts. Excluding all variable consideration until it is fully guaranteed goes further than the standard requires, since ASC 606 expects entities to estimate variable consideration using the expected value or most likely amount methods and then apply the constraint, rather than waiting for certainty. Waiting until cash is received to recognize revenue conflicts with the core recognition principle of ASC 606, which requires recognition when or as performance obligations are satisfied and the resulting consideration is estimated, not simply when cash changes hands.
Source: FASB Accounting Standards Codification: ASC 606-10-32-11, Revenue from Contracts with Customers — Constraining Estimates of Variable Consideration