Final answer:
Companies recognize variable consideration when they estimate it's highly probable that a significant reversal will not occur upon resolution of uncertainties.
Step-by-step explanation:
Companies recognize variable consideration when they have a contract that includes variable amounts of payments. This can occur in various forms such as discounts, rebates, refunds, credits, incentives, performance bonuses, or penalties. According to revenue recognition standards, specifically those outlined by the Financial Accounting Standards Board (FASB) in their Accounting Standards Codification (ASC) Topic 606, companies must estimate the amount of variable consideration to which they will be entitled in order to recognize revenue.
Variable consideration should only be accounted for when it is highly probable that a significant reversal of the amount of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is subsequently resolved. Companies often use either the expected value method or the most likely amount method for estimating the amount of variable consideration. The selected method should reflect the company's expectations of the consideration amount based on the terms of the contract and their past practices.
SUMUP of key points:
- Variable consideration includes various forms of variable payment amounts in a contract.
- Revenue recognition standards require an estimate of variable consideration for recognizing revenue.
- Estimated using the expected value or most likely amount method and included when significant reversal is not highly probable.