Revenue Recognition Under ASC 606
ASC 606 (Revenue from Contracts with Customers) is one of the most tested topics on the FAR section of the CPA exam. The standard applies to all contracts with customers (except leases, insurance, and financial instruments) and uses a five-step model.
The Five-Step Revenue Recognition Model
| Step | Action | Key Considerations |
|---|---|---|
| Step 1 | Identify the contract with a customer | Both parties approved; rights and payment terms identifiable; commercial substance; collection probable |
| Step 2 | Identify the performance obligations | Distinct goods/services; capable of being distinct AND separately identifiable within the contract |
| Step 3 | Determine the transaction price | Consider variable consideration, significant financing components, noncash consideration, consideration payable to customer |
| Step 4 | Allocate the transaction price to performance obligations | Based on relative standalone selling prices; use adjusted market assessment, expected cost plus margin, or residual approach |
| Step 5 | Recognize revenue when (or as) performance obligations are satisfied | Point in time OR over time; transfer of control is the trigger |
Contract Existence Criteria (Step 1)
All five criteria must be met:
- Both parties have approved the contract and are committed to their obligations
- Each party's rights regarding goods/services can be identified
- Payment terms can be identified
- The contract has commercial substance (risk, timing, or amount of future cash flows will change)
- It is probable the entity will collect the consideration to which it is entitled
Distinct Performance Obligations (Step 2)
A good or service is distinct if BOTH conditions are met:
- Capable of being distinct: The customer can benefit from the good or service on its own or together with other readily available resources
- Separately identifiable: The promise to transfer is separately identifiable from other promises in the contract (not highly interdependent or interrelated)
Variable Consideration (Step 3)
| Method | When to Use | Calculation |
|---|---|---|
| Expected Value | Large number of contracts with similar characteristics | Probability-weighted sum of possible outcomes |
| Most Likely Amount | Contract has only two possible outcomes (e.g., performance bonus: earned or not) | Single most likely outcome |
Constraint on Variable Consideration: Include variable consideration in the transaction price only to the extent it is highly probable that a significant reversal of cumulative revenue will NOT occur.
Over Time vs. Point in Time (Step 5)
Revenue is recognized over time if ANY one criterion is met:
- Customer simultaneously receives and consumes the benefits (e.g., routine services)
- Entity's performance creates or enhances an asset the customer controls (e.g., building on customer's land)
- Entity's performance does not create an asset with alternative use AND the entity has an enforceable right to payment for performance completed to date
If none are met, revenue is recognized at a point in time when control transfers (indicators: right to payment, legal title, physical possession, risks and rewards, customer acceptance).
Measuring Progress (Over Time)
| Method | Type | Formula |
|---|---|---|
| Cost-to-cost | Input | Costs incurred to date / Total estimated costs |
| Units delivered | Output | Units delivered / Total units promised |
| Surveys of work performed | Output | Based on appraisals or milestones |
Contract Modifications
| Type | Treatment |
|---|---|
| Distinct goods/services at standalone selling price | Treat as a separate contract |
| Distinct goods/services NOT at standalone price | Terminate old contract; create new contract with remaining consideration |
| Not distinct from goods/services already transferred | Cumulative catch-up adjustment (part of original contract) |
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