246 SECTION 1 The Role of Accounting as an Information System Assume the same facts as in Illustration 5–14 , but that after three months TrueTech concludes that, due to low usage of ProSport’s games, the most likely outcome is that True- Tech will not receive the $180,000 bonus. TrueTech would record the following entry in April to reduce its bonus receivable to zero and reflect the adjustment in revenue: Service revenue ............................................................ 90,000 Bonus receivable (reducing the account to zero) .... 90,000 For the remainder of the contract, TrueTech only recognizes revenue in each month associated with the up-front fixed payment of $300,000. Deferred revenue ($300,000 4 6 months) ................... 50,000 Service revenue ....................................................... 50,000 Illustration 5–15 Accounting for Variable Consideration Bonus Receivable 1/1 -0- 1/31 30,000 2/28 30,000 3/31 30,000 4/30 90,000 4/30 -0- Service Revenue 1/1 -0- 1/31 80,000 2/28 80,000 3/31 80,000 4/30 90,000 50,000 5/31 50,000 6/30 50,000 6/30 300,000 Constraint on Recognizing Variable Consideration. Sometimes sellers lack sufficient information to make a good estimate of variable consideration. The concern is that a seller might overestimate variable consideration, recognize revenue based on a transaction price that is too high, and later have to reverse that revenue (and reduce net income) to correct the estimate. To guard against this, sellers only include an estimate of variable consideration in the transaction price to the extent it is “probable” that a significant reversal of revenue recognized to date will not occur when the uncertainty associated with the variable consideration is resolved in the future. 19 Applying this constraint requires judgment on the part of the seller, taking into account all information available. Indicators that a significant revenue reversal could occur include (a) poor evidence on which to base an estimate, (b) dependence of the estimate on factors outside the seller’s control, (c) a history of the seller changing payment terms on similar contracts, (d) a broad range of outcomes that could occur, and (e) a long delay before uncertainty resolves. If a seller changes its opinion regarding whether a constraint on variable consideration is necessary, the seller should update the transaction price in the current reporting period, just as the seller would do for other changes in estimated variable consideration. Illustration 5–16 provides an example. Sellers are limited to recognizing variable consideration to the extent that it is probable that a significant revenue reversal will not occur in the future. Deferred revenue ($300,000 4 6 months) ................... 50,000 Service revenue ....................................................... 50,000 19 IFRS uses the term “highly probable” instead of “probable” in this case. Because IFRS defines “probable” to mean a likelihood greater than 50%, its use of “highly probable” is intended to convey the same likelihood as is conveyed by “probable” in U.S. GAAP. Illustration 5–16 Constraint on Recognizing Variable Consideration Assume the same facts as in Illustration 5–14 , but that initially TrueTech can’t conclude that it is probable that a significant revenue reversal will not occur in the future. In that case, TrueTech is constrained from recognizing revenue associated with variable consideration. It includes only the up-front fixed payment of $300,000 in the transaction price, and recognizes revenue of $50,000 each month. On March 31, after three months of the contract have passed, TrueTech concludes it can make an accurate enough bonus estimate for it to be probable that a significant revenue reversal will not occur. As in Illustration 5–14 , TrueTech estimates a 75% likelihood it will receive the bonus and bases its estimate on the “most likely amount” of $180,000. Since on March 31 the contract is one-half finished (3 of the 6 months have passed), TrueTech records a bonus receivable and service revenue for $90,000 ($180,000 3 3⁄6) , the amount that would (continued)
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