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Intermediate Accounting Practice study materials
Intermediate Accounting Practice study resources

Intermediate Accounting Practice: Revenue Recognition and Contracts with Customers

Intermediate Accounting Practice · Work through your exam, one topic at a time.

All guide sections

Revenue Recognition and Contracts with Customers

What this domain tests

Revenue is tested through the five-step model in ASC 606 and IFRS 15: identifying the contract, identifying performance obligations, determining the transaction price, allocating it, and recognizing revenue when obligations are satisfied. Questions also cover contract costs, principal-agent issues, warranties, returns, and licensing.

The five-step model

  1. Identify the contract: approval, identifiable rights, payment terms, commercial substance, and probable collection.
  2. Identify performance obligations: distinct goods or services that are capable of being distinct and distinct in the context of the contract.
  3. Determine the transaction price: fixed consideration, variable consideration, significant financing component, noncash consideration, and consideration payable to the customer.
  4. Allocate the price based on relative standalone selling price (SSP). Methods include adjusted market assessment, expected cost plus a margin, and the residual approach when SSP is highly variable or uncertain.
  5. Recognize revenue when or as each obligation is satisfied: at a point in time when control transfers, or over time if the customer controls the asset, consumes benefits, or the asset has no alternative use and the entity has a right to payment.

Variable consideration is estimated using the expected value or most likely amount and is constrained to the amount for which a significant revenue reversal is not highly probable. Incremental costs to obtain a contract are capitalized if recoverable, with a practical expedient when the amortization period is one year or less.

Worked example

A contract price is $120,000 for equipment and installation. SSP is $100,000 for equipment and $25,000 for installation, a total of $125,000. Allocate equipment $96,000 ($120,000 x 100/125) and installation $24,000. If equipment transfers at delivery, $96,000 is recognized then; installation revenue is recognized over the installation period. If installation is not distinct, the combined obligation is recognized when the combined item transfers.

Traps

Recognizing revenue at contract signing; treating an assurance-type warranty as a separate performance obligation; ignoring the constraint; allocating a discount to specific obligations without meeting the criteria; treating shipping after control transfers as a separate obligation; and confusing gross principal revenue with net agent commission.