Client Accounting Services

Revenue Recognition – Step 2

Posted on September 8, 2017 by

Dave Van Damme

Dave Van Damme

Share This

Share on facebook
Share on twitter
Share on linkedin
Share on email

Over the past several months, information has been provided about the new revenue recognition standard released by the Financial Accounting Standards Board (FASB). The standard replaces the current revenue guidance found in multiple places in the FASB codification, and provides a single comprehensive standard that will apply to nearly all industries, significantly changing how revenue is recognized.

The standard provides a five step process for recognizing revenue, as follows:

  1. Identify the contract with the customer
  2. Identify the performance obligations in the contract
  3. Determine the transaction price for the contract
  4. Allocate the transaction price to each specific performance obligation
  5. Recognize the revenue when the entity satisfies each performance obligation

Step two, identifying the performance obligations in the contract, is a critical step because it impacts both how much revenue will be recognized, as well as when a company can record revenue.  ASU 606 defines a performance obligation as a promise to provide a good or service to a customer. The promise can be explicitly stated, implicit, or assumed based on customary business practices. Understanding all of the promises in a contract is a challenging part of this new guidance. The contract definition is very broad and is not limited to the goods or services clearly described in the contract. The definition encompasses promises implied by other means such as customary business practices, published policies and specific statements through email or other communication. If any of those promises lead to an expectation by the customer that the entity will deliver a good or service, under the new guidelines, it must be honored.

In order to allocate the transaction price to performance obligations the good or service has to be:

  • A distinct good or service or bundle of goods or services, or
  • A series of distinct goods or services that are materially the same and have the same pattern of transfer to the customer

The FASB describes a distinct good or service as one that generates an economic benefit to the customer on its own or together with other readily available resources. A readily available resource would be a good or service that is sold separately or a resource that the customer already has. A good measure of whether a good or service is distinct, is to determine if it can be sold on a standalone basis. Often times there are multiple performance obligations in a contract. These are accounted for on a standalone basis if they are separately identifiable or distinct from other promises in the contract.

A series of distinct goods or services has the same pattern of transfer if each good or service in the series can be considered a performance obligation satisfied over time. The same method is used to measure progress toward completion for each distinct good or service in the series.

Performance obligations are satisfied and revenue can be recognized when a customer obtains control of the asset or benefits from the services provided. Performance obligations are completed and revenue is recognized either at a point in time or over a period of time, depending on certain facts.

  • At a point in time – a company has to go through the criteria to determine if a performance obligation is satisfied over time. If it does not meet those criteria, then the performance obligation is satisfied and revenue recognized at the point in time when control of the good or service is transferred to the customer.
  • Over a period of time – a performance obligation is satisfied and revenue is recognized over time if any one of the following are met:
    • The customer receives and consumes the benefits of the goods or services as they are provided by the entity (routine, recurring services like a cleaning service are an example of a series of services that are substantially the same and have the same pattern of transfer)
    • The goods or services create or enhance an asset that the customer controls as that asset is created or enhanced (this would be common for contractors who may renovate a home owned by the customer, or build a structure on land owned by the customer)
    • The asset created does not have an alternative use to the entity and the entity has an enforceable right to payment for performance completed to date (some examples are custom design services, or construction of a custom product to customer specifications). An enforceable right to payment for performance completed to date should include the right to costs incurred to date and a reasonable profit margin.

When a performance obligation and revenue is recognized over time, it is similar to what is known in the current revenue recognition literature as percentage of completion. The primary difference is that the revenue is intended to be recognized in a pattern that represents the transfer of control to the customer. The standard provides two acceptable methods of measuring progress:

  • Output method – Revenue is recognized based on the value transferred to the customer relative to the remaining value to be transferred. Some examples would be, surveys of performance completed to date, appraisals of results, milestone reached, time elapsed and units produced.
  • Input method – Revenue is recognized based on the entity’s effort to satisfy the performance obligation, relative to the total expected effort to satisfy the performance obligation. Some examples are, resources consumed, labor hours expended, costs incurred, time elapsed and machine hours used. The input method has to carefully consider if the inputs truly measure progress to completion. For example, materials may be purchased and recorded as inputs to the project, but due to uninstalled materials or inefficiencies resulting in wasted material, the full amount may not properly depict progress.

Once the performance obligations have been identified, then it is time to move to Step 3: Determining the transaction price.

Dave Van Damme

Shareholder

Dave leads the advisory & assurance practice and is well known inside and outside the firm for being both engaged & positive.

Related Insights

Client Accounting Services

5 Benefits of Outsourced Accounting

Posted on May 2, 2022 by

Beth Butchart
Outsourcing key business functions is a common strategy for businesses to lower costs and gain operational efficiencies. In today’s environment where finding skilled resources is a challenge for most, outsourcing solutions also provide a valuable alternative to create much needed capacity and scale up skillsets.

Client Accounting Services

U.S. Expansion: 7 Benefits of Cloud Accounting

Posted on December 20, 2020 by

Teresa Gordon
Now more than ever in today’s world of virtual and remote management of a US investment, cloud accounting tools serve foreign-owned companies well. Here are seven reasons why you should consider cloud accounting when starting a US subsidiary.

Client Accounting Services, COVID-19, General, Tax & Assurance Guidance

Financial Reporting Implications Due to COVID-19

Posted on October 30, 2020 by

Dave Van Damme
COVID-19 has clearly disrupted life as we know it. Despite these disruptions, businesses continue to operate (some at an altered state) and therefore are required to provide financial reporting to stakeholders.

Sign up for our newsletters

Get general business and industry-specific news and knowledge straight from our accounting specialists.

The Sound of Automation Podcast

The Sound of Automation Podcast

Industrial automation businesses are the driving force behind Industry 4.0, and Clayton & McKervey is here to help.

Insights & Perspectives

Data-driven decision making: 3 key insights for business owners

What does it take to build a data-driven business? For self-reliant leaders who feel they’ve hit a plateau when it comes to scaling a business, adopting a data-driven approach can be a breakthrough success strategy. Using data in a more focused way helps good engineers become good entrepreneurs. It’s about creating balance. Here we take a look at key insights for business owners when using data in decision making.

Read More

The Sound of Automation Podcast

Industrial automation businesses are the driving force behind Industry 4.0, and Clayton & McKervey is here to help.

Skip to content