Step 3 of Revenue Recognition: Determine the Contract Transaction Price

Transaction PricingAccording to the Financial Accounting Standards Board’s (FASB’s) Revenue from Contracts with Customers (referred to hereafter as “the standard”), there are five steps to the revenue recognition process. In this article, we discuss the third step of recognizing revenue: determining transaction price.

Transaction Pricing Basics

The transaction price is the basis for measuring revenue. It is the amount a customer promises to pay for goods or services – excluding third-party collections (e.g., sales tax) – and is affected by both the nature and timing of consideration to be received. In terms of the previous two revenue recognition steps, the transaction price is the amount allocated to performance obligations identified in a contract and thus the amount of revenue recognized as those obligations are satisfied.

When the amount a customer pays is fixed and received at the time of sale, this step of revenue recognition is fairly straightforward. Under the new standard, the path gets more convoluted because the transaction price can vary based on contract terms and be paid over time.

Transaction Pricing Complexities

One of the most significant changes in the standard is the treatment of variable consideration. Variable consideration accounts for factors such as volume and prompt-payment discounts, rebates, royalties, incentives, and contingencies (e.g., returns). Thus, entities often use estimates, as well as judgment, to determine its impact on revenue recognition. For the most part, current accounting principles require that variable revenue amounts be recognized only when the circumstances making them variable are resolved.

The standard now requires the seller to assess the likelihood that variable revenue (both positive and negative) will ultimately be realized. If realization is deemed probable, then that revenue should be included in the transaction price. This provision could have significant implications for construction contractors, manufacturers, and retailers.

Right of return creates another twist in the maze. The standard notes that returns should affect the transaction price, as total consideration received will depend on whether or not the customer keeps the product. Under the old rules, an allowance to offset sales was created, and it updated each reporting period to account for returns on the back end. Now, return expectations are reflected upfront in transaction price determinations — that is, revenue should never be recorded for expected returns.

Noncash Consideration

At least one part of the standard remains unchanged: Noncash items received in exchange for goods or services (i.e., “noncash consideration”) should be recorded at either their fair value or a standalone selling price. What is new: Sellers must consider when they get control of the noncash assets — and whether there is uncertainty in timing or amount that could make the assets subject to the variable consideration guidelines.

CRI Can Help You Navigate the Twists and Turns of Determining Your Contracts’ Transaction Price

Transaction pricing complexities do not have to create lengthy detours on the path to revenue recognition. CRI can help streamline your route. Contact us if you need help determining the transaction price for your contracts.