The ASC 606 transition for construction contractors: Determining the transaction price – Variable consideration

After identifying the contract and the performance obligations within the contract, the next step for a construction contractor under ASC 606 is to determine the transaction price. The transaction price is the amount of consideration to which the contractor expects to be entitled in exchange for satisfying its performance obligations, excluding amounts collected on behalf of third parties (i.e., sales tax).

In the construction industry, the transaction price is generally the contract price under the terms of the contract and may include fixed amounts, variable amounts or both. Determining the transaction price under the new standard requires contractors apply judgment and document processes and controls related to variable consideration, noncash consideration and the existence of a significant financing component.

Variable consideration

When the consideration promised in a contract includes a variable amount, a contractor is required to estimate the amount of consideration to which it will be entitled. Variable consideration may include items such as discounts, rebates, credits, incentives, performance bonuses, penalties or other incentives that are unknown at contract inception. Amounts are only included in the transaction price if it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur in the future.

To the extent that variable consideration is probable (generally at least a 75 percent chance of occurring) that a significant reversal in the amount of cumulative revenue recognized will not occur in the future, a contractor should estimate the amount of variable consideration using either the expected value or most likely amount methods to determine the amount of variable consideration to include in the transaction price. The method a contractor selects is not a policy choice; the estimation is driven by the facts and circumstances of each contract. The chosen method should be applied consistently throughout the contract and throughout contracts with similar terms and requires documentation of management’s conclusions. The estimate used at contract inception should be revisited each reporting period for changes in the probability assessment.

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