Revenue Recognition

5 conditions that must be met.

Mnemonic: Istar

1. Identify the contract with the customer

2. Identify the separate performance obligations in the contract

3. Determine the transaction price

4. Allocate the transaction price to the separate performance obligations

5. Recognize revenue when or as the entity satisfies each performance obligation

Criteria for identifying the contract:

The five step approach is applied only when a contract with a customer meets all of the following criteria:

1. All parties have approved the contract and have committed to perform their obligation

2. The rights of each party regarding contracted goods or services are identified

3. Payment terms can be identified

4. The contract has commercial substance, meaning future cash flows (amount, risk, and timing) are expected to change as a result of the contract.

5. It is probable (based on the customers intent and ability to pay when due) that the entity will collect substantially all of the consideration due under the contract.

Non cancelable or a legal document?

Non cancelable or a legal document, are NOT required factors in determining revenue recognition requirements.

Warranty’s: we need to distinguish between an assurance warranty and a service warranty.

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Example – determined the transaction price

Note: exclude any amounts that benefits a third party and exclude promotions from the price. See picture.

The time value of money

Note: the transaction price should not be adjusted for the effect of the time value of money if the time between the payment and the delivery of the promise is good or service to the customer is one year or less.

The present value of the amount is what’s recorded at the time of the transaction. If there’s a difference in interest, the interest will be recognized as interest income over the relevant periods ahead. The interest income must be presented in the income statement separately from revenue from contracts with customers.

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Variable consideration – probability weighted expected value

Note: if the consideration is variable, set the transaction price based on either the most likely amount (given) or the probability – weighted expected value.

Allocating the transaction price to the separate performance obligations

1. The best evidence of a standalone selling price is the price that can be observed for good or service when the entity sells it separately in similar circumstances to similar customers.

Step #5 – recognize revenue as performance obligations are satisfied

Note: if a customer places an order, but has no immediate need for the product, and asked the company to wait 60 days before delivering the products, when should the revenue be recognized by the company?

When the product has been delivered to the customer.

A. Delivery to the customer ensures that control of the inventory is transferred to the customer, and as a result, the company has satisfied the performance obligation and can record revenue.

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Output and input methods.

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Incremental costs to obtain a contract

Direct incremental cost: represent cost that would not otherwise be incurred if the contract had not been obtained.

These direct incremental cost are recognized as an asset if the entity expects that it can recover these cost.

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Principal versus Agent

When an agent uses a principle to provide services to a customer, the entity is acting as the agent and can only book the net revenue, not the gross revenue.

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Consigner versus consignee

Consigner: the true owner of goods, but is unable to sell them. For this reason, the consigner ships the goods to a sales agent, known as a consignee.

Consignee gets temporary possession of the goods, but not title.

You must know the journal entries for both consigner and consignee.

Consignment basis, journal entry example

Construction contract revenue, recognized over time

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Note: revenue recognized at a point in time: no revenue is recognized until the contract is completed. The exception is, if there is a loss, than the loss is immediately recognized.

Long-term contract Gross profit computation continued:

See examples below

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