Authored by Tom Sheahan and Erik Schuchardt
If the transaction price changes due to an uncertainty, such as a change related to variable consideration, the subsequent change in the transaction price shall be allocated to the performance obligations on the same basis as at contract inception. The transaction price shall not be reallocated to reflect changes in standalone selling prices after contract inception.
When contracts include variable consideration, it is possible that changes in the transaction price can arise after a modification, and such changes may or may not be related to performance obligations that existed before the modification. For changes in the transaction price arising after a contract modification, for which the contract modification was not treated as a separate contract, a contractor must apply one of the following approaches:
- A contractor shall allocate the change in transaction price to the performance obligations identified in the contract before the modification if, and to the extent that, the change in transaction price is attributable to an amount of variable consideration promised before the modification and the modification is accounted for as the termination of an existing contract and the creation of a new contract.
- In all other cases for which the modification is not accounted for as a separate contract, a contractor shall allocate the change in transaction price to the performance obligations modified in the contract (that is, the performance obligations that were unsatisfied or partially unsatisfied immediately after the modification).
A scenario in construction
A contractor enters into a single contract with a customer to construct foundations and raise towers for 100 windmills at an agreed upon price of $100,000 per windmill, totaling $10 million. The customer controls the land on which the windmills will be constructed. The contract terms include a $1 million incentive if all windmills are completed within 24 months from the date of the contract. At contract inception, the contractor is not confident it can meet the 24-month completion timeline.
After 12 months, the contractor has delivered 40 windmills and the customer has agreed to a change order to add 50 additional windmills to the original contract at $95,000 per windmill. The change order increased the incentive timeline to 36 months from the contract inception date for all 150 windmills. The contractor determined that the standalone selling price of the additional 50 windmills is $100,000 per windmill. At this time, the contractor has determined it is now probable that all windmills will be completed by the 36-month deadline.
The contractor previously concluded that the original contract represented a series of distinct goods or services that should be treated as one performance obligation and that the performance obligation is satisfied over time as the windmills are completed. Because the change order does not represent the standalone selling price of the windmills, the change order should not be accounted for as a separate contract. However, because the additional windmills in the change order are distinct from the windmills already delivered, the change order should result in the termination of the original contract and the creation of a new contract. The impact of the change order and recognition of the incentive award should be accounted for as follows:
Prior to the change order:
|Price per windmill||$100,000|
|Number of windmills||40|
|Total consideration recognized||$4,000,000|
Effects of the change order:
|Price per windmill||$100,000||$95,000|
|Number of windmills||60||50|
|Total remaining consideration||$6,000,000||$4,750,000||$10,750,000|
|Windmills to be completed||110|
|Price per windmill after change order||$97,727|
|Number of windmills||150|
|Incentive price per windmill||$6,667||$6,667|
|Price per windmill after change order and incentive||$104,394|
|Incentive price per windmill||$6,667|
|Number of windmills delivered prior to the change order||40|
|Additional revenue recognized at the change order date for performance obligations previously satisfied (change in estimate)||$266,680|
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The ASC 606 transition for construction contractors
- Allocating the transaction price – Standalone selling price
- Allocating the transaction price – Allocating variable consideration