Expected value vs most likely amount — when to use each for variable consideration?

Question

AcadiFi · Accepted Answer

ASC 606 and IFRS 15 provide two methods for estimating variable consideration: (1) the expected value method — the sum of probability-weighted outcomes — suited to contracts with many similar outcomes; and (2) the most likely amount method — the single most likely outcome — suited to contracts with only two possible outcomes (e.g., a bonus earned or not). The method chosen must best predict the amount to which the entity will be entitled and be applied consistently. Example — expected value: Vantuel Chemicals offers tiered volume rebates: 0% for <100k units, 3% for 100k-150k, 6% for >150k. Probabilities: 20%, 55%, 25%. Expected rebate % = 0% x 0.20 + 3% x 0.55 + 6% x 0.25 = 3.15%. On $4M sales, variable consideration deduction = $126,000. Example — most likely amount: Carrowlade Construction has an on-time completion bonus of $800,000 (binary — earned or not). Probability of earning = 70%. Most likely outcome = $800,000; this is added to the transaction price in full (not probability-weighted to $560,000). The method is reassessed each reporting period; updated estimates are adjusted through revenue. Always apply the constraint (next question) to avoid recognizing reversible amounts.

Expected value vs most likely amount — when to use each for variable consideration?

Master Level II with our CFA Course

Related Questions

Practice Questions