Breaking Down the Proposed New Revenue Recognition Standard: Step 3
In my previous blog (www.graymatterblog.com) I outlined the steps an entity would take to determine when and how much revenue to recognize for a contract under the proposed new standard and introduced steps one and two an entity would use in that process. Below we further our discussion by outlining step three.
Step 3: Determine the transaction price
The transaction price is defined in the proposed standard as the amount of consideration an entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties (for ex: sales tax). An entity will consider the following when determining the transaction price of a contract under the proposed standard:
- Variable consideration (for ex: rebates and discounts) – In a variable contract the entity will estimate the transaction price using either the expected value method or the most likely amount method, depending on which method is a better indicator.
- The time value of money – When the period of time between the transfer of goods or services and payment by the customer exceeds one year, and the total payment by the customer exceeds the cash selling price of those goods or services, the contract is considered to have a financing component and therefore must be discounted and interest revenue recognized.
- Noncash consideration – Noncash consideration from a customer would be measured at fair value if it can be determined; otherwise, the noncash consideration is measured indirectly at the standalone selling price of the goods or services transferred to the customer.
- Consideration payable to the customer (for ex: cash or credit) – Consideration payable to a customer are amounts the customer can use to reduce amounts owed to the entity. The consideration payable to the customer would be a reduction in the transaction price of the contract and thus, revenue.
Contact your Anders trusted advisor to learn more about how the proposed standard could affect your company, and stay tuned to www.graymatterblog.com for outlines of steps four and five.