Accounting: The Language of Business - Vol. 2 (Intermediate: Part 125)

The modern profession also has its roots in Scotland in the mid-1800s when the Institute of Accountants in Glasgow petitioned Queen Victoria for a Royal Charter, so accountants could distinguish themselves from solicitors, as for a long time accountants had belonged to associations of solicitors, which would offer accounting in addition to a firm’s legal services. In 1854 the institute adopted ‘chartered accountant’ for its members, a term and demarcation that still carries legal weight globally today.

 Revenue Recognition (Part L)

by

Charles Lamson

Step 5: Recognize Revenue When, or As, Each Performance Obligation Is Satisfied (continued from Part 124)

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

Recall from Part 124 that 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 over time (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.

Transfer at a Point in Time

If the seller does not meet the three criteria to recognize revenue over time, then she assumes that the goods or services are transferred at a point in time. It is often straightforward to determine when control is transferred. For example, consider a retailer that sells computers. Control is transferred when a customer purchases a computer at the retailer, takes delivery at the register, and pays for a computer at the point of sale. However, other times it is more difficult to make the determination. In these cases, the entity should consider a number of indicators of the transfer of control to the customer: 

1. The seller has a present right to payment for the asset.

2. The customer has legal title to the asset.

3. The seller has transferred physical possession of the asset.

4. The customer has the significant risks and rewards of ownership of the asset.

5. The customer has accepted the asset.

These five conditions indicate that control may have transferred, but any one of them does not determine whether control has actually passed to the customer. The entity should consider all of the facts and circumstances to make this determination. Example 8.19 provides an illustration of goods transferred as of a point in time.

Exhibit 8.6 summarizes determining when to recognize revenue.

Summary of the Five-Step Revenue Recognition Process

Now that we have discussed each of the five steps in detail, we illustrate an application in a comprehensive example. Exhibit 8.7 presents a summary of the revenue recognition process in graphical form as a guide for this analysis.

*GORDON, RAEDY, SANNELLA, 2019, INTERMEDIATE ACCOUNTING, 2ND ED., PP. 395-397*

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