Accounting Spotlight June 24, 2019 1 FASB Accounting Standards Update (ASU) No. 2014-09, Revenue From Contracts With Customers (Topic 606). 2 For a full list of final ASUs issued by the FASB to amend and clarify the guidance in ASU 2014-09, see
Section 19.2.2 of Deloitte’s A Roadmap to Applying the New Revenue Recognition
Standard. The guidance in ASU 2014-09, as amended, is codified primarily in FASB Accounting Standards Codification (ASC) Topic 606, Revenue From Contracts With Customers, and FASB Accounting Standards Codification Subtopic 340-40, Other Assets and Deferred Costs: Contracts With Customers. The Spotlight series is prepared by members of Deloitte’s National Office. New issues in the series are released as developments warrant. This publication contains general information only and Deloitte is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte shall not be responsible for any loss sustained by any person who relies on this publication. As used in this document, “Deloitte“ means Deloitte & Touche LLP, a subsidiary of Deloitte LLP. Please see www.deloitte.com/us/about for a detailed description of our legal structure. Certain services may not be available to attest clients under the rules and regulations of public accounting. Copyright © 2022 Deloitte Development LLC. All rights reserved. Accounting Resources for ASC 606 and IFRS 15The core principle of recognizing revenue is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASC 606 and IFRS 15, both titled Revenue from Contracts with Customers, prescribes a 5-step model entities should follow in order to recognize revenue in accordance with the core principle. These five steps are:
We’ve published this accounting topic page to help you learn more about the recognition of revenue, including accounting issues and GAAP differences. We also provide helpful links to our blog posts and eLearning courses on the topic, as well as external thought leadership published by Big 4 accounting firms. It’s a smorgasbord of ASC 606 and IFRS 15 knowledge all in one convenient location!
The 5-step model within IFRS 15 and ASC 606 applies to ALL contracts with customers,
regardless of industry, unless the contract is within the scope of other guidance (for example, leases within the scope of ASC 842). In this section, we’ll walk through each of the 5 steps that must be applied to recognize revenue arising from a contract with a customer and focus on a few of the application issues with more widespread relevance across industries and transactions. Step 1: Identify the contract(s) with a customerOverviewA contract is an agreement between two or more parties that creates enforceable rights and obligations. Enforceability of the rights and obligations in a contract is a matter of law. Contracts can be written, oral, or implied by an entity’s customary business practices. An entity should account for a contract with a customer that is within the scope of ASC 606 only when all of the following criteria are met:
If an arrangement fails to meet all of these criteria at contract inception, it does not qualify as a contract, and no revenue should be recognized under either ASC 606 or IFRS 15. The entity should continue to re-evaluate these criteria each reporting period until the contract meets the criteria. Accounting issue: Change in collectibility of a contractWhile step 1 seems fairly straightforward, sometimes its application can pose a challenge. One aspect of identifying a contract is to ensure it is probable (or highly probable under IFRS) that the entity will collect substantially all of the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer. If collectability is not probable, then you don’t really have a contract and no revenue should be recognized. What happens if a contract is deemed collectible at contract inception, but subsequently, perhaps even years after the contract was established, collectibility is no longer probable? If a contract with a customer meets the criteria in Step 1 at contract inception, an entity does not reassess those criteria unless there is an indication of a significant change in facts and circumstances. The assessment of whether a significant change in facts and circumstances occurred is situation-specific and often a matter of judgment. If such a significant change does occur, and collectibility is no longer probable, the entity is precluded from recognizing additional revenue under the contract until collectibility again becomes probable or the entity receives nonrefundable consideration and other criteria are met (e.g., performance has been completed, the contract is terminated, etc.). Step 2: Identify performance obligationsOverviewAccording to ASC 606 and IFRS 15, a performance obligation is a promise in a contract with a customer to transfer to the customer either:
A good or service that is promised to a customer is distinct if both of the following criteria are met:
If a promised good or service is not distinct, an entity combines that good or service with other promised goods or services until it identifies a bundle of goods or services that is distinct. In some cases, all the goods or services promised in a contract would be treated as a single performance obligation. Generally, a contract with a customer explicitly states the goods or services that an entity has promised to a customer, but not always. This is because a contract with a customer may also include promises that are implied by an entity’s customary business practices, published policies, or specific statements. If, at the time of entering the contract, those promises create a valid expectation of the customer that the entity will transfer a good or service to a customer, these promises could also be performance obligations. However, performance obligations do not include activities that an entity must undertake to fulfill a contract, unless those activities transfer a good or service to a customer. Accounting issue: WarrantiesASC 606 and IFRS 15 introduce two types of warranties: service-type warranties and assurance-type warranties. Service-type warranties If the customer has the option to purchase the warranty separately or if the warranty provides a service to the customer beyond fixing defects that existed at the time of sale, the entity is providing a service-type warranty. The Boards determined that this type of warranty represents a distinct service and is a separate performance obligation. Therefore, the entity allocates a portion of the transaction price to the service-type warranty based on the estimated standalone selling price of the warranty. The entity then recognizes revenue allocated to this type of warranty over the period the warranty service is provided. Assurance-type warranties The Boards concluded that assurance-type warranties do not provide an additional good or service to the customer (i.e., not a separate performance obligation). By providing this type of warranty, the selling entity has effectively provided a guarantee of quality. Under the standard, these types of warranties are accounted for as warranty obligations, and the estimated cost of satisfying them is accrued in accordance with other relevant guidance. Certain arrangements may include both an assurance-type warranty and a service-type warranty. However, if an entity provides both an assurance-type and service-type warranty within an arrangement and the entity cannot reasonably account for them separately, the warranties are accounted for as a single performance obligation (i.e., revenue would be allocated to the combined warranty and recognized over the period the warranty services are provided). When an assurance-type warranty and a service-type warranty can be accounted for separately, an entity is required to accrue for the expected costs associated with the assurance-type warranty and defer the revenue for the service-type warranty. We discuss the accounting for both types of warranties in this post. Step 3: Determine the transaction priceOverviewIn step 3, we determine the amount the entity expects to receive for satisfying the performance obligations in revenue contracts with customers. This transaction price may include fixed amounts set forth in the contract, variable amounts, or both. It might also include adjustments for significant financing arrangements (i.e., time value of money) or the fair value of any non-cash consideration received. Variable consideration is very broadly defined and can be either explicitly or implicitly set forth in the contract. Variability takes many forms and includes discounts, rebates, customer incentives, refunds, credits, performance bonuses, penalties, contingencies, and price concessions. To estimate variable consideration, entities use one of two methods and apply the method consistently throughout the term of the contract:
When estimating variable consideration, entities should only include amounts they are likely to realize and, therefore, not subject to significant revenue reversal (sometimes referred to as the “revenue constraint”). In making this determination, entities need to consider factors that might increase the chances of revenue reversal. Accounting issue: Significant financing componentThe guidance states that time value of money is reflected in a vendor’s estimate of the transaction price if the contract has a financing component that is significant to the contract using the discount rate that would be reflected in a separate financing transaction between the vendor and the customer at the inception of the contract. Any financing component is recognized as interest expense (when the customer pays in advance) or interest income (when the customer pays in arrears). An entity should consider all relevant facts and circumstances in assessing whether a contract contains a financing component and whether that financing component is significant to the contract. If so, financing component must be presented separately. You can see an example of this guidance here. This might seem counterintuitive, but a practical way to look at it is that the customer provided the vendor with financing that it would otherwise have had to obtain from another party, thus incurring interest expense. In order to account for this, revenue is “grossed up” using the same discount rate that the vendor would use if it were to enter into a separate financing transaction with the customer. Interest expense is then recognized over time. There is also practical expedient whereby time value of money can be ignored for periods that are one year or less. Step 4: Allocate the transaction price to the performance obligationsOverviewThe whole objective of step 4 is to allocate the transaction price to the various performance obligations identified in step 2 so that we can recognize a reasonable amount of revenue when those performance obligations are satisfied. This allocation is referred to as the relative standalone selling price approach. At a high level, the standalone selling price is the price at which an entity would sell a promised good or service separately to a customer. The best evidence of this standalone price is the observable price of a good or service when the entity actually sells that good or service separately in similar transactions. Although contract prices may represent the standalone selling price of that good or service, this is not always the case. Oftentimes, actual standalone selling prices do not exist, and entities must use an estimation method in order to properly allocate the transaction price. This estimation should always seek to maximize observable inputs, and estimation methods may include:
Accounting issue: Allocation of discounts to the various performance obligationsNormally, an entity allocates any discounts, proportionately, to all the performance obligations in the contracts. However, if an entity has observable evidence the entire discount relates to just certain performance obligations, then the entity allocates a discount entirely to one or more, but not all, performance obligations in the contract, assuming all of the following criteria are met:
If a discount is allocated entirely to one or more performance obligations in the contract, an entity allocates the discount before using the residual approach to estimate the standalone selling price of a good or service Want to see step 4 in action? Check out this video! Step 5: Recognize RevenueOverviewWe have now reached the culmination of the 5-step model. At this point, entities need to determine the timing of their revenue recognition, which should be based on when control of the underlying good or service is transferred to the customer. Control in this context refers to the ability to:
Based on the nature of a revenue contract, customers may obtain control of the related asset either over time or at a point in time. But this is not a choice. You have to EARN revenue recognition over time by meeting one of the following criteria: If control transfers over time, an entity will recognize revenue over the period it satisfies the related performance obligation utilizing a method (i.e., input or output method) that best depicts the progression toward satisfying the performance obligation. Think the percentage-of-completion method used by construction companies. Regardless of what method they choose, entities need to apply the method consistently to similar performance obligations and in similar transactions or arrangements. When control does not transfer over time, entities must determine the point in time in which control of the underlying asset transfers to a customer based on the applicable facts and circumstances. Accounting issue: Recognizing revenue gross as principal or net as agentDetermining whether revenue should be recognized gross as the principal or net as an agent is a “hot topic” with accountants and auditors alike. Why? Because if you get it wrong, your income statement can be grossly overstated or understated with respect to the revenue that is reported. So, getting it right is very important, although it can require a significant amount of judgment. One of the keys to determining whether an entity is a principal or agent in a transaction is to determine the nature of its promise to the customer, which includes considering:
An entity is a principal if it controls the specified good or service before that good or service is transferred to a customer. If an entity is a principal, it presents revenue and cost of sales on a gross basis. Alternatively, if an entity does not control the good or service before it is transferred to the customer, the entity is an agent in the transaction. Agents present revenue net of the related cost of sales in the income statement. In other words, agents basically only report their “commission” as revenue. Control is defined within step 5 and refers to the ability to direct the issue of, and obtain substantially all the remaining benefits from, the asset. However, it is not always clear whether a customer obtains control of the specified good or service. Luckily, ASC 606 and IFRS 15 provided the following three indicators of control that can be useful in determining who is the principal in the transaction:
Want to learn more about principle vs. agent determination and why it matters? Check out this post!
While ASC 606 and IFRS 15 are mostly converged, there still are a few differences which arose when the FASB issued a string of ASUs after both Boards issued their final standards. Although this is not an all-inclusive list, here are the top differences between U.S. GAAP and IFRS related to revenue:
Check out this post for further discussion of the GAAP differences noted above.
Join the Revolution with GAAP Dynamics!GAAP Dynamics training courses are designed to help leading accounting firms, multinational companies, and even the individual CPA move beyond the training status quo! If you’re sick and tired of click-fests or talking heads, our eLearning is for you! Our courses are continually updated, and new courses are constantly being added, so check back often! Below are our courses related to revenue recognition. Revenue: Overview of ASC 606 – ASC 606 Revenue from Contracts with Customers provides a comprehensive revenue
recognition model that applies to a wide range of transactions in all industries. In this CPE-eligible, eLearning course (1.0 CPE) we look at the core principle of ASC 606 and provide an overview of the revenue recognition requirements in U.S. GAAP. You learn about the 5-step model for recognizing revenue found within ASC 606 by going through each step, and then have a chance to apply what you’ve learned by completing a comprehensive case study. If you’re new to accounting for revenue under U.S.
GAAP, this online course is for you! In subsequent online courses, we dive into the details of each of the steps within the 5-step model prescribed by ASC 606. Revenue: Specific Issues – Now that you have a good understanding of accounting for revenue recognition in accordance with U.S. GAAP and the 5-step model found within
ASC 606 Revenue from Contracts with Customers, it’s time to dive into some specific issues associated with the revenue recognition standard. Do you know how to identify a material right in a contract? What about identifying whether you are a principal or an agent? How about accounting for contract modifications? No worries. This CPE-eligible, eLearning course (1.0 CPE) has you covered, answering those questions and more! This online course also covers other practical application issues
associated with the 5-step model such as accounting for warranties and right of return. We’ve recently released a course for each step in the ASC 606 5-step model:
We’ve bundled our existing eLearning courses into an US GAAP revenue collection for big savings! Revenue: Overview of IFRS 15 – Revenue is one of the most important line items in a set of IFRS financial statements. As such, it is important to get the accounting right! IFRS 15, Revenue from Contracts with Customers is your one-stop shop for revenue accounting for all companies, regardless of their industry. This CPE-eligible, eLearning course (1.5 CPE) walks through the key concepts of the 5-step model within IFRS 15, step by step,
and gives you an opportunity to apply what you’ve learned in practice using examples and class discussion questions!
There are numerous resources available related to revenue recognition from contracts with customers under both ASC 606 and IFRS 15. To save you time, we’ve compiled a list of resources below to assist you in your journey to learn more about this exciting topic! Resources from GAAP Dynamics:We’ve written several blog posts on a variety of topics related to recognizing revenue from contracts with customers. Click on the links below to learn more. Step-by-Step – Differences in ASC 605 / SAB 104 and ASC 606This series of posts examines each step in the new five-step revenue recognition model and compares the new guidance to the old guidance under ASC 605 / SAB 104. Each step includes a series of practical examples or questions that reviews the proper accounting under the old standard and highlights how the answer will change under the new standard.
General GuidanceComparing the New Revenue Recognition Standards: IFRS 15 and ASC 606 (August 30, 2016) Technical Corrections to ASC 606: The New Revenue Recognition Standard (February 14, 2017) Five Nuggets from the SEC About ASC 606 Transition (February 21, 2017) Don't Be A Control Freak! Revenue Recognition Criteria (ASC 606 and IFRS 15) (March 21, 2017) A Shortcut For Implementing The New Revenue Standard (ASC 606 / IFRS 15)? (October 17, 2017) Specific IssuesGoodbye ASC 605, Hello 606! Five Non-Revenue Impacts (July 21, 2015) Principal vs. Agent GAAP Revenue Recognition Criteria (ASC 606) (April 4, 2017) Shipping and Handling: New Revenue Recognition Standard (ASC 606) (March 14, 2017) PCAOB Staff Alert No. 15 - Auditing the Revenue Recognition Standard (October 24, 2017) Taxes and the
New Revenue Recognition Standard (ASC 606) (December 5, 2017) Gunga Galunga: Accounting for Nonrefundable Initiation Fees under ASC 606 (January 23, 2018) Examining Contracts under ASC 606: Material Rights (May 8, 2018) To Buy or Not to Buy? Accounting for Warranties under ASC 606 (May 29, 2018) Unanswered Questions in ASC 606: Shipping and Handling (July 3, 2018) Unanswered Questions in ASC 606: Pre-Production Arrangements (July 10, 2018) Recognizing Revenue under ASC 606 when Good Contracts Go Bad (May 7,
2019) Consideration of a Significant Financing Component under ASC 606 (September 3, 2019) Resources from the FASB and IASB:
Resources from Accounting Firms:The Big 4 accounting firms have published informative and thorough guides related to recognizing revenue from contracts with customers. To save you time, we’ve linked to the most recent versions below. U.S. GAAP
IFRS
What are the criteria for revenue recognition over time?Revenue is recognized over time if one of the following conditions is met: The customer simultaneously receives and consumes the economic benefits of the provided asset as the entity performs; The seller's performance creates or enhances an asset controlled by the customer as the asset is created or enhanced; or.
Which of the following is not one of the criteria for revenue recognition?Collection of the cash is not a criterion to recognize revenue under GAAP. Hence, the correct option is C.
Does the performance obligation meet any of the criteria or recognition of revenue over time?Performance obligations are satisfied and revenue can be recognized when a customer obtains control of the asset or benefits from the services provided. Performance obligations are completed and revenue is recognized either at a point in time or over a period of time, depending on certain facts.
Why is the timing of revenue recognition important?The revenue recognition principle, a key feature of accrual-basis accounting, dictates that companies recognize revenue as it is earned, not when they receive payment. Accurate revenue recognition is essential because it directly affects the integrity and consistency of a company's financial reporting.
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