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Revenue recognition - uncertain consideration

Date recorded:

Uncertain consideration

The Boards discussion focused how an entity should determine the transaction price and recognise revenue when the customer promises an amount of consideration that is uncertain. The answer depends on various issues such as the nature of an entity's contractual rights and obligations, and an entity's ability to estimate the outcome of uncertain future events.

The Boards had previously discussed these issues at length in March 2011 and had not made any decisions due to the lack of clarity on the interaction of the various aspects of the revenue model. The staff presented three steps to apply the proposed revenue model. The staff clarified that the pattern of revenue recognition should be included as a measurement issue rather than a recognition issue to be consistent with the tentative decisions reached in the leases project.

a)

Step 1: Determine the transaction price. The staff recommended that the entity needs to determine the transaction price for two reasons: 1) it is the amount allocated to separate performance obligations, and 2) it is an input to the onerous test. The transaction price is the total amount of consideration that the entity expects to receive/realize for the whole contract. The staff recommended that an entity would determine the transaction price at the amount more likely than not to be received, unless the entity has a large number of contracts with similar characteristics in which case the entity would determine the transaction price at the expected value (i.e. the probability- weighted amount). The staffs' recommendation generated significant discussion by the boards on the different measurement methods (best estimate, more likely than not, expected value, median, mode) and potential issues with the staffs' recommendations.

 

a.

The staff clarified that the transaction price mentioned here does not relate to collectability

 

b.

The Boards tentatively decided that in the first instance, an entity should use an expected value technique. If this is not appropriate, the entity should use a mode technique or mean technique and subsequently the best estimate if neither of these techniques work. The Boards asked the staff to revise the wording on the techniques used to determine transaction price.

b)

Step 2: Allocate the transaction price. The staff recommended that an entity should allocate to each separate obligation the amount of consideration the entity expects to receive in exchange for satisfying that performance obligation. This is discussed in the following section. The Boards agreed in principle to this allocation for the purposes of determining Step 3.

b)

Step 3: Recognise revenue (if the amount allocated to a satisfied performance obligation is reasonably assured to be received). The staff recommended changing the term from reasonably estimated to reasonably assured on the basis that in some circumstances an entity might be able to reasonably estimate an amount even though the entity is not reasonably assured to receive that amount in accordance with the guidance in the revenue standard. The Boards tentatively agreed with this change in term.

 

i.

The staff recommended that when an entity satisfies a performance obligation, the entity should recognise revenue at the amount allocated to that performance obligation unless the amount is not "reasonably assured" to be received, which would be the case in each of the following circumstances below.

 

 

1.

The customer could avoid paying an additional amount of consideration without breaching the contract (e.g. a sales based royalty)

 

 

2.

The entity has no experience with similar types of contracts (or other persuasive experience)

 

 

3.

The entity has experience, but that experience is not predictive of the outcome of the contract based on an evaluation of various factors (e.g. time until the uncertainty is resolved, susceptibility to factors outside the influence of the entity e.g. volatility in the market, judgment of third parties, and risk of obsolescence of the promised good or service, the extent of the entity's experience, the number and variability of possible consideration amounts).

Most respondents supported a constraint on revenue recognition but the staffs' recommendations generated significant discussion by the Boards on the ways in which to constrain revenue and there were many concerns raised and viewed shared by the Boards. Some of those concerns included inconsistencies with tentative decisions reached in the lease project for lessor accounting, and inconsistency in practice for applying the principles being discussed as well as the situations where amounts would be recognised in determining the overall transaction price but not recognised due to constraints on revenue resulting in potential contingent assets/liabilities. The staff clarified that if there is significant uncertainty, this third revenue constraint would minimise truing up revenue in the future. The staff noted that this would need to be disclosed in the financial statements but that this would be addressed at a future meeting. The Boards tentatively agreed to Step 3 point 1 and 2 and in principle with point 3 but asked the staff to build up point 3 further and to add wording around whether the circumstances are within an entity's control. The Boards also asked the staff to ensure that the revenue recognition principles were consistent with principles of lessor accounting.

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