Revenue Recognition. Renee Rampulla

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Chapter 2 Identifying The Contract With a Customer

      Learning objectives

Overview

      The core principle of the revenue recognition standard is that an entity should recognize revenue to depict the transfer of 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. In order to achieve this core principle, an entity should be able to perform the following:

      

Key point

One key concept to remember is that the five steps are achieved consecutively; meaning if an entity cannot achieve the criteria in step 1 they cannot simply move on to step 2 and so on.

      Key definitions used in this chapter

      Before delving into the application of step 1, it is important to understand the following definitions in the FASB Accounting Standards Codification^® (ASC) master glossary:

       Contract: An agreement between two or more parties that creates enforceable rights and obligations.

       Customer: A party that has contracted with an entity to obtain goods or services that are an output of the entity’s ordinary activities in exchange for consideration.

       Revenue: Inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combination of both) from deriving or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operation.

      A gain is defined in FASB Concept Statement No. 6, Elements of Financial Statement, as:

       Gains are increases in equity (net assets) from peripheral or incidental transactions of an entity and from all other transactions and other events and circumstances affecting the entity except those that result from revenues or investments by owners.

      FASB Concept Statement No. 6, further states in paragraph 84, that

       Gains and losses result from entities’ peripheral or incidental transactions and from other events and circumstances stemming from the environment that may be largely beyond the control of individual entities and their managements. Thus, gains and losses are not all alike. There are several kinds, even in a single entity, and they may be described or classified in a variety of ways that are not necessarily mutually exclusive.

      The difference between revenue and gains

      While revenue and gains may appear to be similar, some significant differences exist. As described in the definition, revenue is the result from an entity’s ongoing major or central operations and activities, meaning revenue is derived from producing goods, rendering services, or other activities. Gains result from an entity’s peripheral or incidental transactions and from other events and circumstances stemming from an environment that may be largely beyond the control of the entity and their management. Understanding the difference between gains and revenue is important because gains from peripheral or incidental transactions are outside the scope of FASB ASC 606, Revenue from Contracts with Customers, and therefore outside any of the course’s content.

      

Exercise 2-1

Based upon the previously mentioned definitions, which of the following are revenue and which are gains?

Knowledge check

      How to identify a contract(s) with a customer

      FASB ASC 606 defines a contract as “an agreement between two or more parties that creates enforceable rights and obligations.” Paragraph 1 of FASB ASC 606-10-25 further specifies that a contract(s) with a customer exists only when all of the following criteria have been met:

      Here are some important considerations when assessing whether a contract exists with a customer: