Revenue Recognition Introduction Flashcards
When does revenue recognition occur?
it occurs when an entity satisfies a performance obligation by transferring either a good or a service to a customer
in order to properly apply the revenue recognition standard, an entity should implement the five-step approach described below:
step 1 - identify the contract with the customer
step 2 - identify the separate performance obligations in the contract
step 3 - determine the transaction price
step 4 - allocate the transaction price to the separate performance obligations
step 5 - recognize revenue when or as the entity satisfies each performance obligation
Step 1: identify the contract(s) with the customer
a contract is defined as an agreement between two or more parties that creates enforceable rights and obligations; depending on an entity’s typical business practices, contracts can be verbal, written, or implied
the five step approach is applied only when a contract with a customer meets all of the following criteria:
All parties have approved the contract and have committed to perform their obligations
The rights of each party regarding contracted goods or services are identified
Payment terms can be identified
The contract has commercial substance, meaning future cash flows (amount, risk, and timing) are expected to change as a result of the contract
It is probable (based on the customer’s intent and ability to pay when due) that the entity will collect substantially all of the consideration due under the contract
a contract modification represents a change in the price or scope (or both) of a contract approved by both parties; when a modification occurs, it is either treated as a new contract or as a modification of the existing contract; the modification is treated as a new contract if: the scope increases due to the addition of distinct goods or services and the price increase appropriately reflects the stand-alone selling prices of the additional goods/services
Step 2: identify the separate performance obligations in the contract
a performance obligation is a promise to transfer a good or a service to a customer; the transfer can be either an individual good or service (or a bundle of goods or services) that is distinct, or a series of goods or services that are substantially the same and are thereby transferred in the same manner; if the promise to transfer a good or a service is not distinct from other goods or services, they will all be combined into a single performance obligation
in order to be distinct, both criteria below must be met: the promise to transfer the good or service is separately identifiable from other goods or services in the contract and the customer can benefit either from the good or service independently or when combined with the customer’s available resources
Step 3: determine the transaction price
the transaction price represents the amount of consideration that an entity can expect to be entitled to receive in exchange for transferring promised goods or services to a customer; the transaction price should be determined based on considering the effects of: variable consideration (and any constraining estimates), significant financing if applicable, noncash considerations, and any consideration payable to the customer (if applicable)
Step 4: allocate the transaction price to the performance obligations in the contract
if there is more than one performance obligation within a contract, the transaction price should be allocated to each separate performance obligation based on the amount of consideration that would be expected for satisfying each unique obligation; the stand-alone selling price (and any applicable discount or variable consideration) of each distinct good or service underlying each performance obligation should be determined at contract inception
a discount should be allocated proportionally to all obligations within the contract
Step 5: recognize revenue when (or as) the entity satisfies a performance obligation
an entity should recognize revenue when the entity satisfies a performance obligation by transferring the good or service to the customer, who thereby obtains control of the asset; control implies the ability to obtain the benefits from and direct the usage of the asset while also preventing other entities from obtaining benefits and directing usage; performance obligations may be satisfied either over time or at a point in time
in order to recognize revenue, the entity must be able to reasonably measure progress toward completion; progress can be measured using output and input methods
output methods: revenue is recognized based on the value to the customer of the goods or services transferred to date relative to the remaining goods or services promised (ex. units produced/delivered, time elapsed, milestones achieved, surveys of performance completed to date, appraisals of results achieved)
input methods: revenue is recognized based on the entity’s efforts or inputs to the satisfaction of the performance obligation relative to the total expected inputs (ex. costs incurred relative to total expected costs, resources consumed, labor hours expended, time elapsed)
if the performance obligation is not satisfied over time, then it is satisfied at a point in time; revenue should be recognized at the point in time when the customer obtains control of the asset
