Five Key Steps to Revenue Recognition

There are five revenue recognition steps provided by FASB and IASB.

1. Identify contracts with customers.
   The definition of the accounting contract in the accounting standard is a little different than the definition of a legal contract in law. The step applies to each contract that has been agreed upon with a customer and meets specified criteria. In some cases, it requires you to combine contracts and account for them as one contract. It also provides requirements for the accounting for contract modifications.
2. Identify performance obligations in contracts.
   A contract includes promises to transfer goods or services to a customer. If those goods or services are distinct, the promises are performance obligations and are accounted for separately. A good or service is distinct if the customer can benefit from the good or service on its own or together with other resources that are readily available to the customer. Your promise to transfer the good or service to the customer is separately identifiable from other promises in the contract.
3. Determine the transaction prices.
   The transaction price is the amount of consideration in a contract that you expect to be entitled to in exchange for transferring promised goods or services to a customer. The transaction price can be a fixed amount of customer consideration, but it may sometimes include variable consideration or consideration in a form other than cash. The transaction price also is adjusted for the effects of the time value of money if the contract includes a significant financing component and for any consideration payable to the customer.
   If the consideration is variable, an entity estimates the amount of consideration that it is entitled to in exchange for the promised goods or services. The estimated amount of variable consideration is included in the transaction price only to the extent that it’s probable that a significant reversal in the amount of cumulative revenue recognized doesn’t occur when the uncertainty associated with the variable consideration is subsequently resolved.
4. Allocate transaction prices.
   You typically allocate the transaction price to each performance obligation based on the relative standalone selling prices of each distinct good or service promised in the contract. If a standalone selling price isn’t observable, you estimate it. Sometimes, the transaction price includes a discount or a variable amount of consideration that relates entirely to a part of the contract. The requirements specify when an entity allocates the discount or variable consideration to one or more, but not all, performance obligations or distinct goods or services in the contract.
5. Recognize revenue when performance obligations are satisfied.
   You recognize revenue when or as it satisfies a performance obligation by transferring a promised good or service to a customer, which is when the customer obtains control of that good or service. The amount of revenue recognized is the amount allocated to the satisfied performance obligation. A performance obligation may be satisfied
   • At a point in time: typically for promises to transfer goods to a customer.
   • Over time: typically for promises to transfer services to a customer.
   For performance obligations satisfied over time, an entity recognizes revenue over time by selecting an appropriate method for measuring the entity’s progress toward complete satisfaction of that performance obligation.