Allocating Variable Consideration in ASC 606

In Step 4 of the ASC 606 revenue model, entities are required to allocate the transaction price to the performance obligations in the contract. The transaction price is generally allocated using the relative standalone selling price method. However, the standard includes two exceptions: allocating discounts and allocating variable consideration. This article explores the process of allocating variable consideration.

Deciding Whether the Exception Applies

In many instances, the expected consideration in a transaction is a variable amount, such as when an entity will get a bonus if it finishes the project ahead of schedule. In these instances, the variable consideration that an entity expects to receive must be estimated. Once the variable consideration has been estimated, the entity must determine if the consideration is attributable to:

All of the performance obligations
One or more, but not all, of the performance obligations (e.g., the consideration is based on the percentage of sales to customers that use a software license when the license is only one portion of the contract)
One or more, but not all, distinct goods or services provided in a series of distinct goods or services that make up one performance obligation (e.g., the price for the second year of a two-year cleaning service contract will increase based on the movement of an inflation index) (see ASC 606-10-32-39)

Based on ASC 606-10-32-40, the variable consideration is allocated to one or more, but not all, of the performance obligations or distinct goods or services if the following two criteria are met:

The terms of the variable payment relate specifically to the entity’s efforts to satisfy a performance obligation or transfer a good or service, or to a specific outcome resulting from that performance.
Allocating the variable amount of consideration entirely to the performance obligation or distinct good or service represents the amount of consideration that the entity would expect to receive for transferring the promised goods or services to the customer.

Allocation Method

If these two criteria are met, the entity is required to allocate the variable consideration to the related performance obligations or distinct goods or services. The following examples illustrate how to allocate variable consideration in the transaction price (see ASC 606-10-55-270 to 55-279).

Example: Allocating Variable Consideration to the Transaction Price

An entity enters into a contract with Customer U for two intellectual property licenses (Licenses X and Y). Each license is considered a separate performance obligation. The standalone selling prices of License X and Y are $800 and $1,000, respectively.

Scenario A- Variable Consideration Assigned to One Performance Obligation
The contract states that the fixed price of License X is $800, and the price of License Y will be 3% of Customer U’s future sales of products that use License Y. The entity estimates the variable consideration (sales-based royalty) to be $1,000.

The entity determines that the variable consideration should be allocated to License Y exclusively by analyzing the two criteria above as follows:

The terms of the variable payment intentionally connect to an outcome of satisfying the performance obligation to transfer License Y (3% of future sales).
Allocating the variable consideration of $1,000 entirely to License Y correctly represents the amount of consideration that the entity would expect to receive in a separate transaction (the standalone selling price of $1,000).

Since the two criteria are met, the entity is required to allocate all of the variable consideration to License Y. The fixed price of $800 will be recognized as revenue when License X is delivered. The standard provides that sales-based royalties should not be included in the transaction price or recognized as revenue until subsequent sales have been made. Therefore, the variable consideration of $1,000 will not be recognized at the transfer of License Y, but as Customer U makes subsequent sales of the license.

Scenario B- Variable Consideration Allocated Based on Standalone Selling Price
The contract includes a fixed price of $300 for License X and variable consideration for License Y based on 5% of Customer U’s future sales of products using the license. The entity estimates the sales-based royalty to be $1,500.

The entity determines that the variable consideration should be allocated to both licenses because the second criterion is not met:

The terms of the variable payment intentionally connect to an outcome of satisfying the performance obligation to transfer License Y (5% of future sales).
Allocating $1,500 entirely to License Y does not represent the consideration the entity would expect to receive because the standalone selling price of $1,000 is significantly lower.

Because the second criterion is not met, the entity is required to allocate the variable consideration to both licenses. License Y is transferred to the customer at contract inception, but License X is transferred three months later. The $300 fixed price is allocated between the two licenses according to the relative standalone selling price method. At the transfer of License Y, $167 of revenue will be recognized, and the remaining $133 will be recognized in three months when License X is transferred.

Assuming the royalty due in the first month is $200, the variable consideration is also allocated between the two licenses according to the relative standalone selling price method. The $111 of revenue related to License Y is recognized, but the $89 related to License X will be recognized as a liability until the performance obligation has been satisfied (the license is transferred).

After License X has been transferred, the liabilities from the first three months of royalties will be reversed and recognized as revenue. Subsequent sales-based royalties will be recognized as revenue for their full amount since the two performance obligations have been completed. The table below shows a summary of the calculations for the fixed contract price and the royalty from the first month.

License	Standalone Selling Price	Contract Fixed Price	Contract Royalty
License X	$800	(800/1,800)*300=$133	(800/1,800)*200=$89
License Y	$1,000	(1,000/1,800)*300=$167	(1,000/1,800)*200=$111
Totals	$1,800	$300	$200

R1 RCM, Inc.: Allocating Variable Consideration

add

In correspondence with the SEC in June 2018, R1 RCM highlighted a practical benefit of applying the variable consideration allocation exception. The company noted that its customer contracts typically span three to ten years, making consideration in the later periods more difficult to estimate. However, because its arrangements meet the criteria in ASC 606-10-32-40, R1 RCM is able to allocate variable consideration to specific portions of the performance obligation. This allows the company to focus on estimating consideration over shorter time horizons, rather than the full contract term, thereby reducing the level of judgment required to account for uncertainty associated with incentive fees.

Ebix Inc.: When to Apply Variable Consideration

add

Ebix’s May 2020 response to an SEC inquiry explained the different allocations of variable consideration in its Software as a Service (SaaS). Ebix does not apply variable consideration to SaaS without upfront customization services, even though it provides a series of distinct services. Ebix explained that, for its SaaS arrangements without upfront customization, subscription fees are fixed or estimable amounts based on what the company expects to receive from the customer. These arrangements are treated as a single performance obligation, and as a result, the variable consideration guidance is not applicable.

In contrast, for SaaS arrangements that include upfront customization services, Ebix applies the variable consideration guidance. The company treats these arrangements as a single performance obligation and allocates revenue from the SaaS transactional usage fees proportionally over the service period. Ebix noted that the customization does not represent a separate performance obligation because it has no standalone value without access to the SaaS platform.

Consistent with this approach, Ebix stated:

The invoiced amount is a reasonable approximation of the revenue that would be allocated to the related period under the variable consideration guidelines in ASC 606-10-32-40. If a SaaS contract includes subscription services or professional services, apart from the upfront customization, these are considered separate performance obligations.

Conclusion

After estimating variable consideration, an entity must allocate it to the performance obligations in the contract. In most cases, the transaction price is allocated to all performance obligations based on their relative standalone selling prices. However, ASC 606 provides two criteria to determine whether variable consideration should be allocated to one or more, but not all, performance obligations. If both criteria are met, the variable consideration is allocated to the specific performance obligations to which it relates.

Editor’s Note

This article reflects guidance under ASC 606, Revenue from Contracts with Customers, as currently codified, including subsequent amendments. The concepts discussed remain relevant as ASC 606 has not undergone substantive changes regarding the allocation of variable consideration.

Resources Consulted

ASC 606-10-32-39 to 32-41, 55-270 to 55-274, 55-275 to 55-279
KPMG, Issues In-Depth: “Revenues from Contracts with Customers.” December 2025. Section 6.6.
PwC: “Revenue from Contracts with Customers.” March 2024. Section 5.5.
EY: “Financial Reporting Developments - Revenue from Contracts with Customers.” August 2025. Section 6.3.
Deloitte: "Revenue Recognition - Allocation of Variable Consideration." November 2025. Section 7.5.