Revenue Recognition Certificate

The Financial Accounting Standards Board (FASB) began a project on revenue recognition back in 2014. The proposed standard went through several iterations before finally being released in 2017. Initial implementation dates were deferred for several reasons. For the most part, companies who follow GAAP are now required to comply with Topic 606: Revenue Recognition for Contracts with Customers.

Topic 606 establishes the principles to report useful information to users of financial statements about the nature, timing, and uncertainty of revenue from contracts with customers. Topic 606 establishes the principles to report information to users of financial statements about the nature, timing, and uncertainty of revenue from contracts with customers. The principles are outlined within a five-step process identified by FASB. On the surface, the five-steps may seem simplistic, but it is crucial for accounting professionals, management, operational professionals and executives to have a complete understanding of the many concepts embedded within each step of the standard.

As an overview, the Standard outlines the five steps of the revenue recognition process as follows:

1. Identify the contract

2. Determine the performance obligations

3. Determine the transaction price

4. Allocate the transaction price to the performance obligations

5. Recognize revenue

This principals-based approach was developed to eliminate the hundreds of pages of guidance (some industry specific) that existed in the previous standard. However, in today’s world nothing is ever as simple as it may seem at first look. The standard identifies many new terms and concepts that a professional must und4rstand to properly comply. A few of those terms and concepts include:

Commercial substance

Enforceable rights and obligations

Distinct goods and services

Non-distinct goods and services

Series of distinct goods and services

Input method

Output method

Variable consideration

Constraints on variable consideration

Adjusted market assessment

Residual value guarantee

Collectability criterion

Expected cost plus margin

Contract combination

Obligations performed over-time and at a point in time

Collaborative arrangements

Guarantees

Portfolio approach

Performance Obligation

Stand-alone selling price

Non-cash consideration

Significant financing components

Consideration payable to the customer

Material right

Collectability

If you looked at some of these concepts and questioned “what does that mean”, then you may consider the need to re-examine your understanding of the revenue recognition process.

As mentioned above, the five-step process includes many specific requirements to ensure that the concept of revenue recognition is properly applied. Just a few of those concepts by steps include:

Step One: Identify the Contract with the Customer

A contract with a customer exists only if all of the following are met:

• The parties to the contract have approved the contract and are committed to perform their respective obligations.

• Each party’s rights can be identified.

• Payment terms are identified.

• The contract has commercial substance.

• Collectability is probable.

A contract does not exist if each party to the contract has the unilateral enforceable right to terminate a wholly unperformed contract without compensating the other party or parties. When evaluating whether collectability of an amount of consideration is probable, an entity needs to consider only the customer’s ability and intention to pay that amount of consideration when it is due. Some entities find the collectability criteria difficult to assess because of certain variables, such as contract modifications or non-cash considerations, that could that potentially affect the criteria.

In addition, certain practices and processes for establishing contracts with customers can vary across legal jurisdictions, industries, and entities. Consumer-friendly laws may invalidate a company’s contracts with its customers if challenged in a court of law. Careful consideration will be needed for contracts that have been approved and committed to by the entity and its customers that may not be enforceable in a court of law in a specific jurisdiction.

Step Two: Determine Performance Obligations

A performance obligation is defined as a promise in a contract with a customer to transfer to the customer either a good or service (or a bundle of goods or services) that is distinct, or

a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer. At the inception of a contract, an entity should identify each performance obligation in the contract with a customer.

This step also introduces the concept of distinct goods and services and how they impact the determination of performance obligations. A good or service is distinct if both of the following are met:

• The customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer (that is, the good or service is capable of being distinct).

• The entity’s promise to transfer the good or service to the customer is separately identifiable from other promises

In addition, the concept of a material right is included and must be considered when determining performance obligations.

Step 3: Determine the transaction price

Transaction price is defined as the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer and not the amount that the entity expects to receive. This means collection risk is not a factor used in determining the transaction price. The consideration promised in a contract with a customer may include fixed amounts, variable amounts, or both.

The transaction price considers the effects of the following (if present):

Variable consideration

The existence of a significant financing component in the contract

Noncash consideration

Consideration payable to a customer

Constraining estimates of variable consideration

Step 4: Allocate the transaction price to the performance obligations

Allocation of transaction price introduces some new complexities. One is determination of stand-alone selling price. This is the price an entity would sell a promised good or service separately to a customer. The best evidence of a stand-alone selling price is the observable price of a good or service when the entity sells that good or service separately in similar circumstances and to similar customers.

Another consideration in transaction prices is a material right. When an option to acquire additional goods or services provides a material right to the customer, the customer is, in effect, paying in advance for future goods or services, and revenue attributable to the material right is recognized when those future goods or services are transferred or when the option expires. FASB ASC 606 explains that the estimate of the standalone selling price of a customer option should reflect the discount that the customer would obtain when exercising the option, adjusted for both any discount that the customer could receive without exercising the option

Step Five: Recognize revenue

The standard basis final recognition upon the entity’s satisfaction of a performance obligation and their transferring of control of that obligation to the customer. An entity should recognize revenue when (or as) the entity satisfies a performance obligation by transferring a promised good or service to a customer. An asset is transferred when (or as) the customer obtains control of that asset. Control of an asset refers to the ability to direct the use of, and obtain substantially all of the remaining benefits, from the asset.

The Revenue Recognition Certification on Illumeo.com was developed to provide the professional with a comprehensive overview and understanding of each of the individual five steps to ensure proper revenue recognition. Also, specific case studies and scenarios were built into each course to allow the professional to practice their understanding for a deeper learning experience. This certification program will provide the professional with a well-rounded understanding of all aspects of Topic 606 and enable you to become a revenue recognition subject-matter expert for your organization.