Question

What are the five steps used to determine the proper time to recognize revenue?

Short answer

The steps used to determine the appropriate time for recognition of revenue are:

• Recognition of the contract,
• Identification of performance obligations,
• Determination of transaction value,
• Allocation of transaction value
• Recognition of revenue when the performance obligation is satisfied.

Step-by-step solution

Definition of Revenue Recognition

Revenue recognition is defined as the method of recognizing revenue at the point of sale or services rendered.

Steps used for determining the proper time for recognizing revenue

• Identification of the contract with the customer: The contract can be written, verbal, or implied and should specify payment terms as well as rights of business and customers with regard to the goods or services that will be transferred.

• Identifying performance obligations of the contract: Here, the performance obligation is identified. A performance obligation is an obligation made to the customer to transfer goods or services as per the norms stated in the contract.

• Determining the price of the transaction: The third step specifies that the contract may involve fixed consideration as well as variable consideration. In the case of variable consideration, the amount one is entitled to be calculated with the help of the expected value method.

• Allocation of the transaction price in accordance with the performance obligations: The prices must be set in relation to sale prices, prices stated in the contract, or at the marked price. It can also be estimated by using methods like adjusted market assessment, expected cost plus margin, or residual.

• Recognition of revenue when the performance obligation is satisfied: In this step, revenue is to be recognized either overtime or at a point in time. In the case of recognizing revenue over time, a single method of measuring progress is used. If the performance fails to meet the norms set earlier, revenue is to be recognized at a point in time.