Apply Five-Step Revenue Recognition Model
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CPA Financial Accounting and Reporting (FAR) › Apply Five-Step Revenue Recognition Model
A for-profit manufacturer enters into a contract to deliver 1,000 units of product at $200 per unit ($200,000 total). The contract includes a price concession clause: if the customer’s annual purchases exceed 5,000 units (including this contract), the price per unit for this contract is reduced retroactively by $10 per unit. Management estimates a 70% probability the threshold will be met and concludes it is probable that a significant reversal will not occur if the reduction is included. Which step of the revenue recognition model does the situation illustrate most directly?
Step 1: Identify the contract with a customer, because the price concession clause affects enforceability.
Step 5: Recognize revenue, because retroactive discounts are accounted for only when the threshold is achieved.
Step 2: Identify the performance obligations, because the retroactive discount creates an additional promised good or service.
Step 3: Determine the transaction price, including estimating variable consideration and applying the constraint.
Explanation
This question tests Step 3 of ASC 606 - determining the transaction price when variable consideration exists. The key facts are: a retroactive volume discount creates variable consideration, management estimates 70% probability of achieving the threshold, and the constraint is satisfied (no probable significant reversal). The correct answer identifies this as a Step 3 issue because the entity must estimate variable consideration ($10,000 discount × 70% = $7,000 reduction) and apply the constraint per ASC 606-10-32-11 through 32-13. Option A incorrectly suggests the variable consideration affects contract existence, when enforceable rights clearly exist. Option B mischaracterizes the discount as creating additional performance obligations rather than affecting pricing. Option D incorrectly suggests waiting until the threshold is achieved, violating the requirement to estimate variable consideration at inception. The transferable framework: variable consideration (discounts, rebates, penalties) must be estimated at contract inception using either expected value or most likely amount methods, then constrained to amounts where significant reversal is not probable when uncertainties resolve.