Definition
Variable consideration is contract consideration that depends on future events: discounts, rebates, refunds, credits, price concessions, performance bonuses, penalties, or rights of return. The entity estimates it using either the expected value method (probability-weighted) or the most likely amount, whichever better predicts the outcome. It includes the estimate in the transaction price only to the extent it is probable that a significant reversal of cumulative revenue will not occur when the uncertainty resolves (the constraint).
Why it matters in an audit or review
Estimates drive revenue timing and are tested under AU-C 540: data used, method, assumptions, and look-back to actual outcomes. The estimate is reassessed each reporting period. Auditors compare estimates with subsequent credit memos and returns.
Example
(Illustrative) A manufacturer sells $200,000 of product with a right of return. Historical data show 5% of sales are returned.
Dr Accounts receivable 200,000 Cr Revenue 190,000 Cr Refund liability 10,000
Cost of the expected returns is recorded as a return asset.
Common mistakes
- Choosing the estimation method for convenience instead of the one that better predicts the amount.
- Not updating the estimate after year-end information.
Sources
- FASB ASC 606-10-32-5 through 32-14 (estimating and constraining variable consideration)
- FASB ASC 606-10-55-22 through 55-29 (rights of return)
- AICPA, AU-C Section 540, Auditing Accounting Estimates and Related Disclosures
Definitions paraphrase AICPA and FASB guidance; read the standard itself before relying on a requirement. Example figures are illustrative. This page is guidance, not professional advice. Report an error