B2W Flipbooks

Page | 21 Evaluating Variable Consideration (continued) > A contractor will need to assess at the start of the contract all information (historical, current and forecasted) to determine the contract price. Contractors need to consider the following steps in calculating the amount of variable consideration in the contract: 1. Step 1 – identify all variable considerations associated with a given contract or performance obligation. 2. Step 2 – determine which items if any can be grouped together due to similar characteristics for evaluation. 3. Step 3 – document the amount of the variable consideration using information that the contractor typically uses during the bid and proposal process as well as information used in establishing prices for promised goods. After identifying all the variable considerations, a contractor must assess the amount of variable consideration to include in the transaction price and should consider both the likelihood and magnitude of a revenue reversal. An estimate of variable consideration is not constrained if the potential reversal of the cumulative revenue reversal recognized is not signifi cant. The contractor should consider the probability of the constraint to the contract price. For a reversal to be "probable" GAAP utilizes a 70-80% likelihood of occurence. The amount of the estimated variable consideration to be included in the contract price should be calculated based on one of two methods – (1) the expected value method, or (2) the most likely amount. a. The expected value approach works particularly well with the portfolio method of aggregating customer contracts. If management makes reasonable estimates and applies them to a large number of similar contracts, the aggregate amount of revenue should refl ect the sum of all of the expected amounts of the individual contracts. The expected value approach also works well in situations where there is a spectrum of amounts possible, as in the example above, where there is a bonus for each day prior to a deadline that an entity completes a performance obligation (or a penalty for each day late). b. The most likely amount approach may be the better predictor when the contractor expects to be entitled to one of only two possible amounts. The entity is required to use the method that best predicts this amount and this method should be applied consistently throughout the contract (not a policy choice). Diff erent methods may be used for diff erent forms of variable consideration under the contract. Expected value is typically recommended when there are several possible outcomes (such as number of days prior to substantial completion date) and most likely amount when there are binary outcomes (such as an award received for meeting a milestone date or not). Bonus/incentives that represent possible outcomes are typically explicitly described in the contract. However, the standard does not preclude the use of the most likely amount approach when there are multiple possible outcomes (not binary) if in the judgment of management the method is the better measurement.

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