Revenue Recognition 5-Step Model

Step 1

identify the contract:

- satisfy legal req. for contract

- satisfy additional GAAP req.

Legal Requirements for Contract

offer, acceptance, consideration, lawful purpose, capacity

(written, oral, implied)

Additional GAAP Requirements for Contract

-does economic event justify rev. rec.

- approval, commitment, enforceable (1 party can't terminate)

- probable collection (>80%)

- payment terms identifiable

-commercial substance

Step 2

identify performance obligations:

- if multiple goods/services, are they distinct:

* seperate benefit test

* seperate identification test

Performance Obligation

is a company's promise in a contract to transfer distinct good(s)/service(s) to a customer. EACH distinct good(s)/service(s) is a seperate perf. oblg.

Separate Benefit Test

customer can benefit from good/service on its own

Separate Identification Test

good/service is separately/distinctly identifiable from other promises in the contract

Step 3

Identify the price:

- fixed price -> consideration readily determinable

- BUT exists are -> variable considerations

* price depend on future events

* only include if company reasonably assured it will be entitled to that amount

Criteria for Recognizing Variable Considerations

(1) have prior experience with similar contracts & are able to estimate the revenue

(2) based on experience, is highly probable will not be a significant reversal of revenue previously recognized

Step 4

allocate transaction price:

- allocate transaction price to each perf. oblg. in proportion to stand-alone selling prices

Step 5

recognize revenue:

- recognized only when perf. oblg. satisfied and there is transfer of control of good/service

- keep in mind perf. oblg. over time (spaced out over their time)