Variable consideration and the constraint under IFRS 15

What counts as variable consideration?

Volume rebates, early-payment discounts, price concessions, refunds and rights of return, performance bonuses, penalties for late delivery, and prices that depend on an index. It also includes consideration that is variable because the company has a history of granting concessions, even if the contract does not mention them.

Where does it come up most?

In consumer goods, through volume rebates and promotional payments to retailers; in pharmaceuticals, through rebates and chargebacks; in construction, through performance bonuses, penalties and claims; in retail and e-commerce, through returns; and in software, through usage-based fees. Each of these needs an estimate at every reporting date.

How is it estimated?

The company uses the method that better predicts the amount it will be entitled to, and applies it consistently to similar contracts.

A worked example: a volume rebate

A manufacturer sells components at CU 100 a unit. If the customer buys more than 1,000 units in the year, it receives a 10% rebate on all units bought. Based on the customer's orders and forecasts, the manufacturer judges there is an 80% chance the threshold will be reached.

• Expected value: 80% x CU 90 + 20% x CU 100 = CU 92 a unit.
• Most likely amount: the threshold is most likely to be met, so CU 90 a unit.

With only two possible outcomes, the most likely amount better predicts the result, so the manufacturer uses CU 90. Selling 300 units in the first quarter, it records:

If by year end the customer is clearly going to fall short, the refund liability is released to revenue. The Revenue allocation calculator (Excel) has a variable consideration sheet that compares both methods for up to five outcomes.

What is the constraint?

An estimate is included in the transaction price only to the extent that it is highly probable that a significant reversal of cumulative revenue will not occur when the uncertainty is resolved. Factors that make reversal more likely include amounts that depend on factors outside the company's control, such as weather or market prices, limited experience with similar contracts, a long period before the uncertainty resolves, and a wide range of possible outcomes. US GAAP uses the word "probable" for the same threshold.

How are returns handled?

For goods sold with a right of return, the company recognises revenue only for the goods it expects to keep sold, a refund liability for the expected returns, and an asset for its right to recover the returned goods, measured at their former carrying amount less recovery costs.

Goods shipped to dealers who pay only when they sell on are a different case: no sale has happened yet. See consignment arrangements.

Is there an exception?

Yes. For sales-based or usage-based royalties on a licence of intellectual property, revenue is recognised only when the later of the sale or usage and the satisfaction of the performance obligation occurs. The company does not estimate future royalties.

Does the estimate change?

At each reporting date the company updates its estimate and the constraint assessment, and adjusts revenue for the change. Changes are allocated to the performance obligations on the same basis as at the start of the contract. See allocating the transaction price.

This guide is general information. It is not tax or legal advice for your situation.