Revenue Recognition Issue 7 – Recognize Revenue When/As Performance Obligations Are Satisfied
Now that you have identified the contract and the underlying performance obligations, gathered information to assess the transaction price, and allocated the transaction price to the individual performance obligations, in this final step you’ll need to determine when to recognize revenue on the transaction(s) under the contract. This is without a doubt the most complicated part of the new standards, as there are situations under which you would recognize revenue over the life of the contract, situations where you would recognize revenue at the completion of the contract, and even situations where you would recognize some revenue over the life of the contract and some at completion (based on your assessment of specific performance obligations.)
In general, you will recognize revenue over the life of the contract if any one of the following applies:
- The customer receives and consumes the benefits provided by your performance as you perform.
- Your performance creates or enhances an asset that the customer controls as the asset is created or enhanced (such as repairs to your customer’s car or remodeling your customer’s kitchen.)
- Your performance does not create an asset with an alternative use to the customer and the customer has an enforceable right to payment for performance completed to date.
If none of the above three criteria apply, then you would generally recognize revenue when the customer gains control of the goods/services under the enforceable contract.
When recognizing revenue over the life of the contract, there is an input method and an output method to use in determining your progress under the contract. The output method uses performance metrics such as contractual milestones or surveys to determine progress; the input method uses internal dynamics such as costs incurred, time spent, materials applied (exclusive of uninstalled materials) or machine hours to assess the progress under the contract.
You will also see cases where none of the considerations above apply and then you need to look at certain control factors to see when you should recognize revenue. Some of these control factors could include whether the customer has a current right to pay for the product, whether they have title to the product, whether you have transferred possession of the product to them, whether the customer has obtained the significant risks and rewards of ownership of the product, and whether the customer has accepted the product from you.
Seem complicated? Well – it is. No brief article will fully prepare you for answering the question as to how to recognize revenue. You need to use professional judgment, along with the other knowledgeable members of your management team (most significantly, sales leadership involvement) to make these determinations.
Please contact your BMF Advisor for additional information regarding the new standards.
James E. Merklin?>
CPA/CFF, CFE, CGMA, MAcc
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