LO 17.1 Prior to ASU 2014-09 changing the principles underlying revenue recognition, companies recognized revenue
when it was earned and realized. The principles of earned and realized were replaced with a core principle which states
that companies should recognize 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.
To accomplish this core principle, the FASB and the IASB stated that companies should follow a 5-step process.
Required:
1. Discuss the 5-step process that companies should use to accomplish the core principle of revenue recognition.
Revenue recognition principle states that every business organization should recognize the revenue when it is earned,
even if cash related to that obligation is not received.
5 criteria that should be met for a contract to be accounted for using the 5-step model in the revenue standard:
1. The "revenue recognition model" is applicable to those contracts that are approved by all parties either in a written
form, orally or by implication. The company must be able to recognize the rights of each party with respect to goods and
services transferred. The company must be able to recognize terms of payment with respect to goods and services
transferred. The contract must have a commercial substance. This means that the contract should change the amount,
timing, or possibility of the company's future cash flows. It must be possible for the company to collect the consideration
to which it is entitled in "exchange for the goods or services" that will be transferred to the customer.
2. A contract must have a promise for "transferring goods and services" to a customer. Recognizing "performance
obligations" is straightforward.
3. Transaction price is the amount of consideration that is estimated by the company to be authorized in exchange, for
delivering the promised goods and services to the customer. The transaction price is examined by the seller by analyzing
the terms of the contract and the normal conduct of the business. Various factors must be considered for establishing
the transaction price, comprising if there is a variable consideration, noncash consideration amounts payable to
customers, and a considerable financing component.
4. The transaction price is assigned to the "performance obligations" separately in the contract depending upon the"
relative stand-alone selling prices". The revenue standard provides three approaches that can be used to estimate a
"stand-alone selling price" when one is not directly recognizable and they are as follows - adjusted market assessment
approach, expected cost plus a margin approach, residual approach.
5. As the "performance obligations" are satisfied, Revenue is recognized. The "revenue standard" provides assistance to
ascertain, if a performance obligation is satisfied at a point in time or over time.
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