Solving the Revenue Recognition Maze: Step 5, Recognizing Revenue

Recognize RevenueAccording to the Financial Accounting Standards Board’s (FASB’s) Revenue from Contracts with Customers (referred to hereafter as “the standard”), there are five steps to the revenue recognition process. In this article, we discuss the fifth and final step of recognizing revenue: allocating transaction price.

Passing a Checkpoint: Recognizing Revenue When (or As) Control Transfers

In the fifth revenue recognition step, sellers recognize revenue when they satisfy performance obligations to reflect the actual transfer of control over assets sold to customers. The amounts recognized are the transaction prices that were allocated to performance obligations in step four. Sometimes, though, the transfer happens over a period of time rather than at a specific point in time.

“Control” refers to the ability to substantially retain and direct the use of an asset’s benefits (and prevent others from doing so). The standard notes that the following circumstances may indicate transfer of control:

  • The buyer has physical possession, legal title, or significant risks and rewards of ownership.
  • The buyer has accepted the asset.
  • The seller has an enforceable right to payment.

Management must apply judgment to decide when factors like these constitute a transfer. (Note: this decision is made in step two as performance obligations are identified). The timing of revenue recognition is relatively straightforward when control transfers at a particular point in time (e.g., upon delivery). This determination can be tricky when control transfers over time, as it sometimes does with intellectual property.

Making Sharp Turns for Transfers over Time

The standard says that control transfers over time if any of the following are true:

  • The customer receives and consumes the benefits of the asset as the seller performs the service (e.g., service contracts).
  • The customer controls the asset while it is being created, customized, or enhanced (e.g., work in process for some manufacturing contracts)
  • The seller is creating an asset that cannot be redirected to another use or customer and the seller has an enforceable right to payment for work completed to date (e.g., a printer receiving a business card order).

When performance obligations are satisfied over time, the amount of revenue to recognize depends on the measure of progress completed. Progress measurement methods should mirror the transfer of control as much as possible and be based on either:

  • inputs, or efforts expended to date (e.g., materials and labor); or
  • outputs, or the value of transfers to date (e.g., units delivered or the appraised value of the asset at each milestone).

These measurements should be updated regularly so that recognized revenue always reflects the seller’s performance to date.

This milestone-based methodology for recognizing revenue from long-term contracts is a significant change for many companies. Telecommunications companies that sell wireless phones and accompanying service contracts, for example, may recognize more revenue upfront — upon delivery of the higher-valued handset — and less revenue over the remainder of the contract as monthly services are delivered.

CRI Can Help You Finish the Revenue Recognition Maze

Don’t let the complexities of long-term contracts hold you up on the path to revenue recognition. CRI is here to help you understand the implications of the new standard. Contact us for assistance with implementation and planning. For more of our revenue recognition news and resources, visit the Revenue Recognition section of the CRI website.

2018-11-12T15:45:05+00:00March 28th, 2017|REVENUE RECOGNITION|