Final answer:
To manage expected returns in a contract, a company must establish a contractual asset or liability. Cost analysis, considering fixed and variable costs, alongside sales, revenue, and market structure, is critical for strategic long-term profitability.
Step-by-step explanation:
Under the contract base approach, when management estimates the extent of expected returns as a form of variable consideration, the company must establish a contractual asset or liability. This involves recognizing revenue to the extent that it is probable that a significant reversal will not occur when the uncertainty associated with the variable consideration is subsequently resolved. In determining the transaction price, a company must consider the effects of variability in determining whether to recognize revenue at a point in time or over time.
Every firm gains insights into profitability by classifying costs into fixed and variable costs, and using these to calculate average total cost, average variable cost, and marginal cost. This cost analysis, combined with an analysis of sales and revenue that considers the market structure, informs decisions on production and pricing to maximize profits. Firms analyze their cost structures from a long-run perspective to make strategic decisions for sustainable profitability.