The draft Revenue Recognition standard: Steps 3 and 4 

Lets first look at variable consideration - Consideration may be variable as a result of incentives, including discounts and rebates, contingent or performance-based fees or other similar items.

If the consideration in a contract is variable, then a company would estimate using one of two methods;

the expected value; or the most likely amount.

However, this is not a free choice and it would depend on whether one or the other approach better predicts the amount of consideration to which a company expects to be entitled.

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Now lets look at how credit risk is treated in the new ED – The transaction price would not be adjusted for customer credit risk in the new ED. The ED requires that the effects of customer credit risk be presented as a line item adjacent to revenue in the statement of comprehensive income. Any impairment losses on trade receivables and on contract assets would be recorded separately from revenue but on this adjacent line (i.e. above the gross profit margin).

Collectability is not a criteria for revenue recognition in the ED.  US GAAP reporters will be familiar with confirm that collectability is probable or reasonably assured.  This is not one of the criteria in the new ED, although the credit risk is reflected adjacent to revenue.

Lastly lets look at how to reflect the time value of money.  The 2011 ED proposes that a company adjust the amount of consideration to reflect the time value of money if the contract includes a significant implicit or explicit financing component.

As a practical expedient, a company would not be required to make this assessment if the period between transfer of control of goods or services and payment is expected to be one year or less.

IFRSs do not contain an explicit requirement to adjust advance payments to reflect the time value of money and there is divergence in practice at present. Under the 2011 ED, both payments received in advance and in arrears would be subject to the time value of money requirements.

Step 4 - The 2011 ED retains the proposal to allocate, at contract inception, the transaction price to separate performance obligations in proportion to their relative stand-alone selling prices. When stand-alone selling prices are not directly observable, a company would estimate them using a suitable approach, such as the adjusted market assessment approach, expected cost plus a margin approach or, in limited circumstances, the residual approach.  The 2011 ED allows use of the residual approach if prices are highly variable or uncertain.

US GAAP preparers will note the hurdle of VSOE and VSOE related deferrals will stop – this may lead to commercial teams having greater freedom to bespoke offerings to customers.

US GAAP reporters will also be familiar with applying the residual method where the value of delivered elements is determined by assessing the fair value of all the other undelivered elements and subtracting from the total.  This will be permitted in the new ED where prices are ‘highly variable’.