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Variable Consideration Accounting: Estimating Variable Pricing in Contractual Arrangements
The transaction price includes variable consideration. Which one of the following statements is reasonable? Trust in Law Inc. defends Carl in a civil court case. 80% of Trust in Law Inc.’s fee is based on the positive outcome of the court case. There is a 75% chance that the court case will have a positive outcome and a 25% chance that it will not. Trust in Law Inc. determines that the most likely amount is the method that better predicts the amount of consideration to which it will be entitled. Build Together Ltd. constructs an oil rig for G&O Inc. and is entitled to a bonus if the rig is completed by a set date, but subject to escalating penalties for each day it is not. In considering the likelihood of the bonus or penalties Build Together Ltd. determines that there is a large number of possible outcomes and therefore uses the most likely amount to estimate variable consideration. Hotline Crisis Ltd. buys 1,000 telephones from TelTel Inc. at a fixed price per telephone. Hotline Crisis Ltd. has the ability to return the telephones to TelTel Inc. if they determine that they are not suitable for their national crisis line service. Given the price per phone is fixed the transaction price is fixed, i.e., Tele Services Inc. has no variable consideration.

According to the accounting principles, variable consideration refers to elements of a transaction price that may change depending on future events. In the case of Trust in Law Inc., where 80% of their fee is contingent on the outcome of the court case, the appropriate method to estimate variable consideration would be to use the most likely amount, as this approach better predicts the amount of consideration to which the company will be entitled given the 75% probability of a positive outcome.

On the other hand, for Build Together Ltd., the potential bonus or penalty structure for completing the oil rig construction by a specific date introduces a wide range of possible outcomes. In such scenarios, using the most likely amount might not be the best estimate of variable consideration because it doesn't account for the range of possible outcomes. Instead, the expected value or probability-weighted method might be more appropriate for estimating the variable consideration in this case.

Lastly, in the example of Hotline Crisis Ltd. purchasing telephones from TelTel Inc., since there's no variable price component in the transaction (returning the phones does not qualify as variable consideration under the context of the purchase, only the fixed price per telephone), the transaction price for TelTel Inc. would be considered fixed, with no variable consideration involved.

In conclusion, the treatment of variable consideration varies depending on the specifics of each contract and the predictability of the outcome.