Accounting: The Language of Business - Vol. 2 (Intermediate: Part 124)

With the onset of the industrial revolution in 1760, there was a proliferation of companies and the need for more advanced accounting systems. The development of corporations also created larger groups of investors, and more complex structures of ownership, all requiring accounting systems to adapt.

Revenue Recognition (Part K)

by

Charles Lamson

Step 5: Recognize Revenue When, or As, Each Performance Obligation Is Satisfied (continued from Part 123)

Recall from Exhibit 8.1 from Part 114 and reintroduced below, the five steps in revenue recognition. In this post, we discuss Step 5.

Companies determine when to recognize revenue in Step 5 based on when the goods or services are transferred to the customer. A good or service is transferred when the customer obtains control. A customer has control of the asset if it has the ability to direct the use of the asset and receives all (or substantially all) of the remaining benefits of owning the asset.

Transfer over Time

Goods and services may be transferred to the customer over time or at a point in time. If the goods or services are transferred over time, then the seller recognizes revenue over that time period. However, if the goods or services are transferred to the customer at a point in time, then the seller recognizes the revenue at that point in time. Companies must determine whether the goods/services are transferred over time or as of a point in time at the Inception of the contract.

Goods or services are transferred over time if the seller meets any one of the following three criteria:

1. The customer receives and consumes the benefits of the goods or services simultaneously (for example, health club memberships and magazine subscriptions).

2. The customer controls the asset as the seller creates it or enhances it overtime (for example, software updates).

3. The asset the seller is creating does not have an alternative use to the seller, and the seller has an enforceable right to payment for the performance completed to date.

If a good or service is transferred over time, then the seller recognizes revenue over that same time period, based on the progress that it has made toward completion. However, if the seller does not have a reasonable way to measure its progress toward completion, then it should not recognize any revenue until it can reasonably estimate progress. Progress toward completion can be measured using either output methods or input methods. Examples of output methods include units produced or delivered, progress such as floors or miles completed, and time elapsed. Examples of input methods include labor hours expended, machine hours used, and costs incurred.

Example 8.17 illustrates transferring services over time because the customer receives and consumes the benefit simultaneously.

Example 8.18 illustrates a scenario in which the seller recognizes revenue over the service period and the contract meets the second criteria to recognize revenue. Here the customer controls the asset as the seller creates or enhances the item over time.

*GORDON, RAEDY, SANNELLA, 2019, INTERMEDIATE ACCOUNTING, 2ND ED., PP. 393-394*

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