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( ASC 606 ) Step3 : Determine the transaction price

The underlying principle of the new standard is that an entity will recognize revenue to depict the transfer of goods or services to customers at an amount that the entity expects to be entitled to in exchange for those goods or services.

The standard consists of a five-step approach as follows:

Fig : 5 steps Framework

Last post we have seen step 1 and step 2

( ASC 606 ) Step1 : Identify the contract with a customer [1]

( ASC 606 ) Step2 : Identify the performance obligations in the contract [2]

Lets take a quick look on Step 3:

DETERMINE THE TRANSACTION PRICE

The next step is to determine the transaction price, the amount of consideration that the seller expects to be entitled to in exchange for transferring the control of goods or services promised in the contract.

The transaction price is the amount of consideration that an entity expects to be entitled to in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of a third party (i.e. sales taxes).

The transaction price is the amount the business expects to receive in return for transferring the goods or services outlined in Step 1. The amount can be fixed, variable, or a combination, but is allocated specifically to the performance obligations outlined in Step 2.

Therefore , once these performance obligations are fulfilled, the business can recognize this as revenue.

When a certain amount of cash is transferred to the business simultaneously with the promised goods or services, this is quite easy. But, more complex payment arrangements require additional thought.

Variable Consideration and the Constraint on Revenue Recognition:

  • The transaction price may be variable or contingent upon future events, including discounts, refunds, rebates, credits, incentives, performance bonuses, etc.
  • Variable consideration should be estimated based on either the expected value or the most likely amount, defined as follows:
    • Expected Value – Sum of the probability weighted amounts for various possible outcomes.
    • Most Likely Amount – The most likely amount in a range of possible amounts.

There is some suggestion that companies that implement ASC 606 rules early might be able to recognize more upfront revenue on sales, but that shouldn't be taken as a guarantee

To be continued.