Variable Consideration and Contract Costs in Financial Accounting
This module delves into two critical components of revenue recognition under ASC 606: Variable Consideration and Contract Costs. Understanding these concepts is crucial for accurate financial reporting, especially in competitive exams like the CPA.
Variable Consideration
Variable consideration refers to the portion of the consideration promised in a contract for which the amount can vary. This variability can arise from discounts, rebates, performance bonuses, penalties, or other similar items. The key challenge is to estimate this variable consideration and recognize revenue only to the extent that it is highly probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is subsequently resolved.
The expected value method and the most likely amount method.
The 'highly probable' threshold for the constraint on variable consideration is a key differentiator from other accounting standards. It implies a higher degree of certainty is required.
Contract Costs
Contract costs are expenditures incurred in obtaining a contract or fulfilling a contract. These costs can be capitalized if they are incremental to the contract and expected to be recovered. Otherwise, they are expensed as incurred.
| Cost Type | Capitalization Criteria | Recognition |
|---|---|---|
| Incremental Costs of Obtaining a Contract | Incurred to obtain a contract that would not have been incurred if the contract had not been obtained, and are expected to be recovered. | Capitalized and amortized on a systematic basis consistent with the transfer of goods or services. |
| Costs to Fulfill a Contract | Incurred to fulfill a contract and either (a) relate directly to specific contracts, (b) are attributable to general contract activities that can be allocated to specific contracts, or (c) are incurred to obtain a contract that would not have been incurred if the contract had not been obtained. | Capitalized if they are expected to be recovered and relate directly to specific contracts or general contract activities that can be allocated. |
| Costs Not Meeting Criteria | Costs that do not meet the capitalization criteria. | Expensed as incurred. |
When they are incremental and expected to be recovered.
The process of revenue recognition under ASC 606 involves five steps. Variable consideration impacts Step 3 (Determine the transaction price) and Step 4 (Allocate the transaction price). Contract costs are addressed in Step 2 (Identify the performance obligations) and Step 3 (Determine the transaction price) when determining if costs should be capitalized and amortized. The interplay between these concepts is vital for accurate financial reporting.
Text-based content
Library pages focus on text content
Key Considerations for Exams
When tackling questions on variable consideration and contract costs in competitive exams, remember to:
- Identify all sources of variability in consideration.
- Apply the 'highly probable' constraint to limit revenue recognition.
- Differentiate between costs to obtain and costs to fulfill a contract.
- Assess the recoverability of capitalized costs.
- Understand the amortization period for capitalized costs.
The 'highly probable' constraint is a significant hurdle. If there's substantial uncertainty about the amount of consideration, revenue recognition will be limited.
Learning Resources
The official accounting standard from the Financial Accounting Standards Board (FASB) that governs revenue recognition, including detailed guidance on variable consideration and contract costs.
An overview and summary of ASC 606 from the American Institute of Certified Public Accountants (AICPA), often tailored for CPA exam candidates.
A video tutorial explaining the concept of variable consideration and its application in revenue recognition, specifically geared towards CPA exam preparation.
A video explaining the accounting treatment of contract costs, including capitalization and amortization, with examples relevant to the CPA exam.
A blog post that breaks down the complexities of variable consideration in ASC 606 with practical examples and exam tips.
An article from AccountingTools that details the criteria and process for capitalizing contract costs according to ASC 606.
A clear explanation of variable consideration, including the estimation methods and the constraint, from AccountingCoach.
A comprehensive guide to variable consideration and contract costs, offering insights into their accounting treatment and implications.
PwC's overview of the five-step revenue recognition model, which provides context for where variable consideration and contract costs fit in.
Investopedia's definition and explanation of variable consideration in the context of financial accounting and contracts.