What is the objective of the revenue recognition standard in ASC 606?
To provide a single, comprehensive revenue recognition model for all contracts with customers to improve comparability across industries, jurisdictions, and capital markets.
When should revenue be recognized according to the revenue recognition principle?
In the accounting period in which the performance obligation is satisfied.
What are the two types of contract assets?
- Unconditional contract assets - rights to receive consideration because the company has satisfied its performance obligation to a customer and recognizes revenue.
- Conditional contract assets - rights to receive consideration because the company has satisfied some of the performance obligations in the contract and thus recognizes revenue for the performance obligations that are satisfied, but it must satisfy other performance obligations before it can invoice the customer.
What is a contract liability?
It arises when a company receives consideration from the customer before it transfers goods or services to the customer.
What are the five steps to revenue recognition under ASC 606?
- Identify the contract with a customer.
- Identify the separate performance obligations in the contract.
- Determine the transaction price.
- Allocate the transaction price to the separate performance obligations in the contract.
- Recognize revenue when or as each performance obligation is satisfied.
What criteria must a contract meet to be accounted for under ASC 606?
- The parties have approved the contract and are committed to perform their obligations.
- The rights of each party regarding the goods or services to be transferred can be identified.
- The payment terms for the goods or services to be transferred can be identified.
- The contract has commercial substance.
- It is probable that the company will be able to collect substantially all the consideration.
What is a performance obligation in a contract?
A promise in a contract with a customer to transfer a good or service to that customer.
How is the transaction price determined?
It is the amount of consideration that the company expects to be entitled to receive in exchange for transferring the promised goods or services to the customer.
What is variable consideration and what two methods can be used to estimate variable consideration?
It refers to revenue for goods or services that is dependent on future events and the company must estimate the amount it expects to be entitled to receive. It can be estimated using:
- the expected value method: the sum of the probability-weighted amounts within a range of possible amount., or
- the most likely method: the single most likely amount within the range of possible amounts
What should be done if a contract includes a significant financing component?
The consideration should be adjusted using time value of money concepts. Revenue from the contract and a loan receivable should be recognized in the financial statements. The revenue amount should be the present value of the consideration, discounted at an interest rate that reflects inflation and the loan receivable’s credit risk.
How should noncash consideration–such as goods, services, or common stock that has been promised as payment–be measured?
At its fair value.
How should the transaction price be allocated to performance obligations?
Based on the fair value of each performance obligation, using its standalone selling price.
When goods are shipped FOB Shipping Point, what is the main consideration when recognizing revenue for shipping and handling activities?
The goods belong to the customer from the moment the seller gives them to the shipping company, so the shipping and handling activities will be performed after the customer obtains control of the goods.
Revenue for shipping and handling activities can be recognized as separate performance obligations and the company can recognize the shipping and handling revenue after it recognizes the revenue for the goods shipped, generally as the goods are in transit.
Or, the company can make a policy decision to account for all shipping and handling activities as fulfillment activities and allocate all of the revenue to the goods shipped when the shipping takes place.
If recognized as separate performance obligations, a portion of the revenue is allocated to these activities. If recognized as fulfillment activities, revenue is recognized when the product is shipped.
When is revenue for shipping and handling activities recognized for goods shipped FOB Destination?
When goods are shipped FOB Destination, shipping and handling activities are always fulfillment activities. Revenue for the shipping and handling is recognized upon shipment, even though revenue for the goods is not recognized until the goods are delivered.
No policy election is needed for goods shipped FOB Destination as shipping and handling activities are always fulfillment activities.
What are the criteria for recognizing revenue on a long-term contract over time under ASC 606?
- The customer simultaneously receives and consumes the benefits.
- The company’s performance creates or enhances an asset the customer controls.
- The performance does not create an asset with an alternative use, and there is an enforceable right to payment for performance completed to date.
These criteria determine if revenue should be recognized over time or at a point in time.
How should a company recognize revenue for a contract with a right of return?
Revenue should be recognized at the amount the company expects to be entitled to receive, excluding expected returns or refunds.
Companies usually record sales at gross amounts and adjust for returns at the end of each reporting period.
What is the revenue recognition principle for consigned goods?
The consignor recognizes revenue only when control transfers, usually when the goods are sold to the final customer.
The consignor recognizes revenue for the entire selling price, while the consignee recognizes commission revenue when the goods are sold.
What is the accounting treatment for freight costs in consignment transactions?
Freight costs paid by the consignor are inventoriable costs for the consignor.
These costs are recorded as part of the “Goods out on consignment” account.
How is revenue recognized for long-term contracts that do not meet the criteria to be accounted for over time?
Revenue and gross profit are recognized at a point in time, that is, when the customer obtains control of the asset.
This is similar to the completed contract method under legacy GAAP, now referred to as “point in time” recognition.
What is the purpose of the Construction in Process (CIP) account that is used during the work-in-process period on a long-term contract accounted for at a point in time?
The CIP account is a temporary holding account for construction costs incurred during the work-in-process period on a long-term contract accounted for at a point in time. It is a contract asset account.
For a point-in-time contract, costs are debited to the CIP account as incurred. Unlike a work-in-process inventory account, costs in the CIP account do not move to finished goods and then to cost of goods sold.
What happens if a loss is projected on a long-term contract?
The entire estimated contract loss must be recognized in the current period.
This is consistent with guidance in ASC 450-20, Loss Contingencies.
What does the line item on a balance sheet, “Costs of in-process point-in-time contracts in excess of related billings,” represent for a long-term contract?
If on a financial statement date the balance in the contract asset account, Construction in Process (CIP) is greater than the balance in the contract liability account, Billings on Construction in Process (BCP), the difference is reported as a net contract asset.
The line item used is called “costs of in-process point-in-time contracts in excess of related billings” or something similar.
How should total net contract assets and liabilities for several long-term projects be presented on the balance sheet?
Separately, not netted against each other. On its balance sheet, the contractor presents total net contract assets separately from total net contract liabilities, rather than a net position for all contracts with customers.
When must an estimated loss on a point-in-time contract be recognized?
Immediately when anticipated. The entire estimated contract loss must be recognized in the current period.
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