Insights: Article

Revenue Recognition – Step 3: Determine the Transaction Price

By Brian Bluhm

April 18, 2018

As discussed in our initial installment in this series, in the upcoming changes to FASB Accounting Standards Codification Topic 606, Revenue from Contracts with Customers, FASB provides a five-step framework for determining revenue recognition.

The third step in this process is determining the transaction price. While it may seem simple to identify the price in a contract, the new revenue guidance incorporates several additional considerations that will impact nearly all transactions, including retail sales, such as when you buy your morning coffee.

In the new standard, the determination of the transaction price includes an evaluation of consideration due back to a customer. This would include such items as discounts, rebates, coupons, vouchers, incentives, penalties, and credits, including loyalty program rewards. Variable consideration, such as a reward or penalty for finishing a construction project early or late, will be required to be evaluated for probability of fruition at the beginning of a contract in determining the transaction price. Ultimately, the transaction price will be determined based on the net revenue expected over the life of a contract. Many entities provide discount or rebate programs based on volume of sales. In these relationships, sales may be made throughout the year with a rebate check issued at the end of the year. In arrangements such as these, an entity will estimate the rebates to be given and reduce revenue on the revenue transactions during the year in anticipation of the rebate. Volume discount arrangements can have similar attributes in which the discount percentage escalates during the year as sales volume achieved certain thresholds. Again, in such cases, an entity will estimate the discounts in determining the transaction price for the all revenue transactions occurring under the arrangement.

When variability of a contract price exists from items such as rebates, incentives, or any other price concession, an entity needs to evaluate the probability of the occurrence of such items and increase or decrease the transaction price accordingly. The initial assessment is to be made at the beginning of the contract and then subsequently reassessed at the end of each reporting period. For example, an entity establishes a pricing arrangement with a customer that within a 12-month period, the first 500 units purchased will be sold at $100 per unit, the next 500 will be $90 per unit, and anything after 1,000 units will be $85 per unit. The entity performs a probability analysis and concludes that the expected sales for the 12-month period are estimated to be 1,200 units. Accordingly, the total revenue anticipated from the contract is $112,000 (500 units at $100, plus 500 units at $90, plus 200 units at $85). The transaction price for each unit would be $93.33 ($112,000 / 1,200 units). Accordingly, revenue from each individual transaction throughout the 12-month period would then be recorded a $93.33 per unit. If the first shipment is for 100 units, the accounting entries would be as follows:

 

Accounts receivable (100 units a $100)

$ 10,00

 
 

Revenue (100 units at $93.33)

 

$ 9,333

 

Contract liability

 

$  667

The calculation of the transaction price and the creation of a contract liability is a significant shift from revenue recognition policies currently in effect.

Questions? Please contact an Eide Bailly LLP representative today—we can help you through this process!


Catch up on this series!

Revenue Recognition – Step 1: Identify the Contracts with a Customer

Revenue Recognition – Step 2: Identify the Performance Obligation in the Contract

Revenue Recognition – Step 3: Determine the Transaction Price

Revenue Recognition – Step 4: Allocate the Transaction Price to the Performance Obligation in the Contract

Revenue Recognition – Step 5: Recognize Revenue When (or as) the Entity Satisfies a Performance Obligation

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