likely to occur’.69 However, the meaning of ‘probable’ under US GAAP is intended to be the
same as ‘highly probable’ under IFRS. [IFRS 15.BC211].
Furthermore, the IASB noted that an entity’s analysis to determine whether its estimate
of variable consideration should be constrained will largely be qualitative. [IFRS 15.BC212].
That is, an entity will need to use judgement to evaluate whether it has met the objective
of the constraint (i.e. it is highly probable that a significant revenue reversal will not
occur in future periods) considering the factors provided in the standard that increase
the probability of a significant revenue reversal (discussed further below). In addition,
conclusions about amounts that may result in a significant revenue reversal may change
as an entity satisfies a performance obligation.
An entity needs to consider both the likelihood and magnitude of a revenue reversal to
apply the constraint.
• Likelihood – assessing the likelihood of a future reversal of revenue require
significant judgement. Entities want to ensure they adequately document the basis
for their conclusions. The presence of any one of the indicators cited in the extract
above does not necessarily mean that a reversal will occur if the variable
consideration is included in the transaction price. The standard includes ‘factors’,
rather than ‘criteria’, to signal that the list of items to consider is not a checklist for
which all items need to be met. In addition, the factors provided are not meant to
be an all-inclusive list and entities may consider additional factors that are relevant
to their facts and circumstances.
• Magnitude – when assessing the probability of a significant revenue reversal, an
entity is also required to assess the magnitude of that reversal. The constraint is
based on the probability of a reversal of an amount that is ‘significant’ relative to
the cumulative revenue recognised for the contract. When assessing the
significance of the potential revenue reversal, the cumulative revenue recognised
at the date of the potential reversal includes both fixed and variable consideration
and includes revenue recognised from the entire contract, not just the transaction
price allocated to a single performance obligation.
An entity must carefully evaluate the factors that could increase the likelihood or the
magnitude of a revenue reversal, including those listed in paragraph 57 of IFRS 15:
• the amount of consideration is highly susceptible to factors outside the entity’s
influence (e.g. volatility in a market, judgement or actions of third parties, weather
conditions, high risk of obsolescence of the promised good or service);
• the uncertainty about the amount of consideration is not expected to be resolved
for a long period of time;
• the entity’s experience (or other evidence) of similar types of contracts is limited,
or that experience (or other evidence) has limited predictive value;
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• the entity has a practice of either offering a broad range of price concessions or
changing the payment terms and conditions of similar contracts in similar
circumstances; or
• the contract has a large number and broad range of possible consideration amounts.
Example 28.38: Evaluating the factors that could increase the likelihood or
magnitude of a significant revenue reversal
Assume that an insurance broker receives ‘trailing commissions’ of £100 every time a consumer signs up for
a new insurance policy and £50 whenever one of those consumers renews a policy.
In this fact pattern, the broker has a large pool of historical data about customer renewal patterns, given its
significant experience with similar contracts. The broker considers the above factors and notes that the amount
of consideration is highly susceptible to factors outside its influence and the uncertainty could remain over
several years. However, it also has significant experience with similar types of contracts and its experience
has predictive value.
As a result, even though the amount of consideration the entity will be entitled to is uncertain and depends on
the actions of third parties (i.e. customer renewals), it is likely that the entity can estimate a minimum amount
of variable consideration for which it is highly probable that a significant reversal of cumulative revenue will
not occur. Assuming the broker’s performance is complete upon initial signing of a contract, the broker would
recognise the initial £100 fee plus the minimum amount related to future renewals that is not constrained.
There are some types of variable consideration that are frequently included in contracts
that have significant uncertainties. It is likely to be more difficult for an entity to assert
it is highly probable that these types of estimated amounts will not be subsequently
reversed. Examples of the types of variable consideration include the following:
• payments contingent on regulatory approval (e.g. regulatory approval of a new drug);
• long-term commodity supply arrangements that settle based on market prices at
the future delivery date; and
• contingency fees based on litigation or regulatory outcomes (e.g. fees based on the
positive outcome of litigation or the settlement of claims with government agencies).
When an entity determines that it cannot meet the highly probable threshold if it includes
all of the variable consideration in the transaction price, the amount of variable
consideration that must be included in the transaction price is limited to the amount that
would not result in a significant revenue reversal. That is, the estimate of variable
consideration is reduced until it reaches an amount that can be included in the transaction
price that, if subsequently reversed when the uncertainty associated with the variable
consideration is resolved, would not result in a significant reversal of cumulative revenue
recognised. When there is significant uncertainty about the ultimate pricing of a contract,
entities should not default to constraining the estimate of variable consideration to zero.
The standard includes an example in which the application of the constraint limits the
amount of variable consideration included in the transaction price and one in which it
does not. [IFRS 15.IE116-IE123].
Example 28.39: Price concessions
An entity enters into a contract with a customer, a distributor, on 1 December 20X7. The entity transfers
1,000 products at contract inception for a price stated in the contract of CU100 per product (total consideration
is CU100,000). Payment from the customer is due when the customer sells the products to the end customers.
The entity’s customer generally sells the products within 90 days of obtaining them. Control of the products
transfers to the customer on 1 December 20X7.
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On the basis of its past practices and to maintain its relationship with the customer, the entity anticipates granting
a price concession to its customer because this will enable the customer to discount the product and thereby
move the product through the distribution chain. Consequently, the consideration in the contract is variable.
Case A – Estimate of variable consideration is not constrained
> The entity has significant experience selling this and similar products. The observable data indicate that
historically the entity grants a price concession of approximately 20 per cent of the sales price for these
products. Current market information suggests that a 20 per cent reduction in price will be sufficient to move
the products through the distribution chain. The entity has not granted a price concession significantly greater
than 20 per cent in many years.
To estimate the variable consideration to which the entity will be entitled, the entity decides to use the
expected value method (see paragraph 53(a) of IFRS 15) because it is the method that the entity expects to
better predict the amount of consideration to which it will be entitled. Using the expected value method, the
entity estimates the transaction price to be CU80,000 (CU80 × 1,000 products).
The entity also considers the requirements in paragraphs 56–58 of IFRS 15 on constraining estimates of
variable consideration to determine whether the estimated amount of variable consideration of CU80,000 can
be included in the transaction price. The entity considers the factors in paragraph 57 of IFRS 15 and
determines that it has significant previous experience with this product and current market information that
supports its estimate. In addition, despite some uncertainty resulting from factors outside its influence, based
on its current market estimates, the entity expects the price to be resolved within a short time frame. Thus,
the entity concludes that it is highly probable that a significant reversal in the cumulative amount of revenue
recognised (i.e. CU80,000) will not occur when the uncertainty is resolved (i.e. when the total amount of
price concessions is determined). Consequently, the entity recognises CU80,000 as revenue when the
products are transferred on 1 December 20X7.
Case B – Estimate of variable consideration is constrained
The entity has experience selling similar products. However, the entity’s products have a high risk of
obsolescence and the entity is experiencing high volatility in the pricing of its products. The observable data
indicate that historically the entity grants a broad range of price concessions ranging from 20–60 per cent of
the sales price for similar products. Current market information also suggests that a 15–50 per cent reduction
in price may be necessary to move the products through the distribution chain.
To estimate the variable consideration to which the entity will be entitled, the entity decides to use the
expected value method (see paragraph 53(a) of IFRS 15) because it is the method that the entity expects to
better predict the amount of consideration to which it will be entitled. Using the expected value method, the
entity estimates that a discount of 40 per cent will be provided and, therefore, the estimate of the variable
consideration is CU60,000 (CU60 × 1,000 products).
The entity also considers the requirements in paragraphs 56–58 of IFRS 15 on constraining estimates of variable
consideration to determine whether some or all of the estimated amount of variable consideration of CU60,000
can be included in the transaction price. The entity considers the factors in paragraph 57 of IFRS 15 and observes
that the amount of consideration is highly susceptible to factors outside the entity’s influence (i.e. risk of
obsolescence) and it is likely that the entity may be required to provide a broad range of price concessions to
move the products through the distribution chain. Consequently, the entity cannot include its estimate of
CU60,000 (i.e. a discount of 40 per cent) in the transaction price because it cannot conclude that it is highly
probable that a significant reversal in the amount of cumulative revenue recognised will not occur. Although the
entity’s historical price concessions have ranged from 20–60 per cent, market information currently suggests
that a price concession of 15–50 per cent will be necessary. The entity’s actual results have been consistent with
then-current market information in previous, similar transactions. Consequently, the entity concludes that it is
highly probable that a significant reversal in the cumulative amount of revenue recognised will not occur if the
entity includes CU50,000 in the transaction price (CU100 sales price and a 50 per cent price concession) and
therefore, recognises revenue at that amount. Therefore, the entity recognises revenue of CU50,000 when the
products are transferred and reassesses the estimates of the transaction price at each reporting date until the
uncertainty is resolved in accordance with paragraph 59 of IFRS 15.
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In some situations, it is appropriate for an entity to include in the transaction price an
estimate of variable consideration that is not a possible outcome of an individual contract.
The TRG discussed this topic using the following example from the TRG agenda paper.70
Example 28.40: Estimating variable consideration using the expected value method
Entity A develops websites for customers. The contracts include similar terms and conditions and contain a
fixed fee, plus variable consideration for a performance bonus related to the timing of Entity A completing
the website. Based on Entity A’s historical experience, the bonus amounts and associated probabilities for
achieving each bonus are as follows:
Bonus amount
Probability of outcome
– 15%
$50 40%
$100 45%
Analysis
Entity A determines that using the expected value method would better predict the amount of consideration
to which it will be entitled than using the most likely amount method because it has a large number of
contracts that have characteristics that are similar to the new contract.
Under the expected value method, Entity A estimates variable consideration of $65,000 [(0 × 15%) + (50,000 × 40%)
+ (100,000 × 45%)]. Entity A must then consider the effect of applying the constraint on variable consideration. To
do this, Entity A considers the factors that could increase the likelihood of a revenue reversal in paragraph 57 of
IFRS 15 and concludes that it has relevant historical experience with similar types of contracts and that the amount
of consideration is not highly susceptible to factors outside of its influence.
In determining whether the entity would include $50,000 or $65,000 in the transaction price, TRG members
generally agreed that when an entity has concluded that the expected value approach is the appropriate method
to estimate variable consideration, the constraint is also applied based on the expected value method. That is,
the entity is not required to switch from an expected value method to a most likely amount for purposes of
applying the constraint. As a result, if an entity applies the expected value method for a particular contract,
the estimated transaction price may not be a possible outcome in an individual contract. Therefore, the entity
could conclude that, in this example, $65,000 is the appropriate estimate of variable consideration to include
in the transaction price. It is important to note that in this example, the entity had concluded that none of the
factors in paragraph 57 of IFRS 15 or any other factors indicate a likelihood of a significant revenue reversal.
When an entity uses the expected value method and determines that the estimated amount
of variable consideration is not a possible outcome in the indiv
idual contract, the entity
must still consider the constraint on variable consideration. Depending on the facts and
circumstances of each contract, an entity may need to constrain its estimate of variable
consideration, even though it has used an expected value method, if the factors in
paragraph 57 of IFRS 15 indicate a likelihood of a significant revenue reversal. However,
using the expected value method and considering probability-weighted amounts
sometimes achieves the objective of the constraint on variable consideration. When an
entity estimates the transaction price using the expected value method, the entity reduces
the probability of a revenue reversal because the estimate does not include all of the
potential consideration due to the probability weighting of the outcomes. In some cases,
the entity may not need to constrain the estimate of variable consideration if the factors in
paragraph 57 of IFRS 15 do not indicate a likelihood of a significant revenue reversal.
The standard provides the following example of a situation in which a qualitative analysis
of the factors in paragraph 57 of IFRS 15 indicates that it is not highly probable that a
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significant reversal would not occur if an entity includes a performance-based incentive
fee in the transaction price of an investment management contract. [IFRS 15.IE129-IE133].
Example 28.41: Management fees subject to the constraint
On 1 January 20X8, an entity enters into a contract with a client to provide asset management services for
five years. The entity receives a two per cent quarterly management fee based on the client’s assets under
management at the end of each quarter. In addition, the entity receives a performance-based incentive fee of
20 per cent of the fund’s return in excess of the return of an observable market index over the five-year period.
Consequently, both the management fee and the performance fee in the contract are variable consideration.
The entity accounts for the services as a single performance obligation in accordance with paragraph 22(b)
of IFRS 15, because it is providing a series of distinct services that are substantially the same and have the
same pattern of transfer (the services transfer to the customer over time and use the same method to measure
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 418
