Examples of variable consideration include discounts, rebates, refunds, credits, price concession, incentives, performance bonuses and penalties.

IFRS 15 introduces a constraint such that for most types of variable consideration should only be included in the transaction price to the extent that it is highly probable that a significant reversal in the amount of cumulative revenue recognized will not occur.

One of the following methods should be used to estimate the amount of variable consideration, depending on which method better predicts the amount of consideration to which the entity will be entitled:

  1. The expected value method – this may be appropriate when the entity has a large number of contracts with similar characteristics and is calculated as the sum of probability-weighted amounts in a range of possible consideration amounts; and
  2. The most likely amount – this may be appropriate when a contract has only two possible outcomes (e.g. the amount received is based on whether a performance bonus is achieved, or not). It is the single most likely amount in a range of possible consideration amounts (i.e. the single most likely outcome of the contract).

Example 1

Company A enters into a contract on 1 May 20X5 to construct a machine on a customer’s premises.  The consideration was agreed at a price of $300.000 with a bonus of $20.000, if the machine is completed within 2 years. Company A determines that it is highly probable that the bonus will be achieved.

At 30 April 20X6, Company A has satisfied 60% of its performance obligation on the basis of costs incurred to date. At year end the customer has paid an amount of $210.000.

Since it is highly probable that the bonus will be received, revenue recognized will be as follows:

60% * $320.000 ($300.000 + $20.000) = $192.000

The journal is:

DR Cash $210.000

                                CR Revenue $192.000

                                Cr Contract Liability $18.000 (b)

Example 2

Company B sells smartwatches to a variety of customers. Company B uses the following pricing model:

  • The first 200 items purchased in a year cost $250 each,
  • The next 100 smartwatches cost $220 each; and
  • Any additional items beyond that point cost $190 each.

ABC Ltd (ABC) is one of Company B’s clients. Based on past experience Company B estimates that for the current year:

  • There is a 30% probability ABC will acquire 600 smartwatches,
  • 45% likelihood to purchase 700 items; and
  • 25% probability to acquire 800 items.

ABC purchases 150 smartwatches and pays $37.500 (150 * $250).

Requirement: What is the correct journal entry?

Solution 2

100 $220 $22.000
300 $190 $57.000
$250 $50.000
100 $220 $22.000
400 $190 $76.000
200 $250 $50.000
100 $220 $22.000
500 $190 $95.000

In order to calculate revenue per item the expected value approach should be used as per the table above. ABC purchases 150 smartwatches and pays $37.500 (150 * $250). The transaction should be recognized as follows:

DR Cash $37.500

                CR Revenue $31.775 (150 * $211,83)

                CR Contract Liability $ 5.725 (b)