CHAPTER 18
Revenue Recognition
LEARNING OBJECTIVES
1. Understand the fundamental issues related to revenue recognition and measurement.
2. Understand and apply the five-step revenue recognition process.
3. Apply the five-step process to major revenue recognition issues.
CHAPTER REVIEW
1. One of the most difficult issues facing accountants concerns the recognition of revenue by
a business organization. The International Accounting Standards Board and the Financial
New Revenue Recognition Standard
2. (L.O. 1) The asset-liability approach recognizes and measures revenue based on
changes in assets and liabilities. The IASB and FASB decided that focusing on changes
The Five-Step Process
3. (L.O. 2) The five-step process for revenue recognition includes the following steps:
a. Identify the contract with customers.
Identifying the Contract with Customers – Step 1
4. A contract is an agreement between two or more parties that creates enforceable rights
5. Revenue from a contract with a customer cannot be recognized until a contract
exists. Revenue guidance is applied to contracts if:
a. The contract has commercial substance.
6. A contract modification occurs when the contract terms are changed while the contract
is ongoing. When this occurs, companies determine whether
a. A new contract and separate performance obligations result, or
Identifying Separate Performance Obligations – Step 2
7. A performance obligation is a promise in a contract to provide a product or service to a
customer. This promise can be explicit, implicit, or based on customary business
practice. To determine if a performance obligations exists, a company:
Determining the Transaction Price – Step 3
8. The transaction price is the amount of consideration a company expects to receive from
a customer in exchange for transferring goods and services.
b. Companies account for the time value of money when the contract involves a significant
Allocating the Transaction Price to Separate Performance Obligations – Step 4
9. Companies often have to allocate the transaction price to more than one performance
a. Adjusted market assessment approach: estimate the price that customers in that
market are willing to pay for those goods or services.
Recognizing Revenue When (or as) Each Separate Performance Obligation is Satisfied –
Step 5
10. A company satisfies its performance obligation when the customer obtains control of the
good or service. Indicators that the customer has obtained control include:
a. The company has a right to payment for the asset.
Companies recognize revenue over a period of time if the customer receives and
consumes the benefits as the seller performs and one of the two following criteria are
Other Revenue Recognition Issues
11. (L.O. 3) There are a number of other revenue recognition issues illustrated in the text:
a. Right of return: all of the following are recognized (i) revenue for the transferred
products in the amount that is reasonably assured; (ii) a refund liability, and; (iii) an
asset and adjustment to the cost of sales.
revenue of the agent. The agent’s revenue is the amount of commission it receives.
e. Consignments: goods are delivered to a consignee but the consignor retains title
until the goods are sold. The consignor recognizes revenue when
notification is received and/or cash remittance results from a sale that has already
occurred.
Presentation and Disclosure
12. (L.O. 4) Contract assets are of two types: (a) unconditional rights to receive
consideration because the company has satisfied its performance obligation with a
13. Companies disclose qualitative and quantitative information about all of the following:
a. Contracts with customers
*14. (L.O. 5) In most circumstances, revenue is recognized at the point of sale because the
performance obligation is satisfied. One of the exceptions to the general rule of
*15. A company satisfies a performance obligation and recognizes revenue over time if at least
one of the following two criteria is met:
a. The company’s performance creates or enhances an asset (e.g., work in process) that
the customer controls as the asset is created or enhanced; or
b. The company’s performance does not create an asset with an alternative use. For
(iii) The company has a right to payment for its performance completed to date, and it
expects to fulfill the contract as promised
*16. If one of the two criteria described above is met, and if a company can reasonably estimate
Percentage-of-Completion Method
*18. Under the percentage-of-completion method, revenue on long-term construction contracts
is recognized as construction progresses. Costs pertaining to the contract plus gross
profit earned to date are accumulated in a Construction in Process account. The
amount of revenue recognized in each accounting period is based on a percentage of the
total revenue to be recognized on the contract. The most popular method of estimating
the amount of the percentage of completion for revenue recognition is based on the
costs incurred on the contract to date divided by the most recent estimated total
costs (cost-to-cost basis).
a. The journal entry to recognize revenue under the percentage–of-completion method is
as follows:
Construction in Process XXX
Cost-Recovery (Zero-Profit) Method
*19. (L.O. 6) The cost-recovery method recognizes revenue only to the extent of costs
incurred that are expected to be recoverable. Only after all costs are incurred is gross
profit recognized. The accounting journal entries made under the cost-recovery method
Long-Term Contract Losses
*20. (L.O. 7) Two types of losses can occur on long-term contracts (a) losses in the current
period on a profitable contract, and (b) losses on an unprofitable contract. When a
evident under both the percentage-of-completion and the cost-recovery methods.
Revenue Recognition for Franchises
*21. (L.O. 8) Appendix 18B includes a presentation of franchise sales transactions. In
franchise operations, a franchisor grants business rights under a franchise agreement
*22. Initial franchise fees are to be recorded as revenue only when and as the franchisor
makes “substantial performance” of the services it is obligated to perform and collection
LECTURE OUTLINE
The material in this chapter can be covered in three class sessions. Students are generally
unfamiliar with revenue recognition bases other than at point of sale.
A. (L.O. 1) Overview of Revenue Recognition
1. Revenue recognition: One of the most difficult problems facing the accounting
2. The IASB and FASB issued a converged new revenue recognition standard that
provides a set of comprehensive guidelines using the asset-liability approach to recognize
3. (L.O. 2) The five-step process for revenue recognition includes the following steps:
a. Identify the contract with customers.
4. The contract is an agreement between two or more parties that creates enforceable rights
or obligations and can be oral, written, or implied from customary business practices.
a. When there are multiple contracts, separate accounting may or may not occur,
5. A performance obligation is a promise in a contract to provide a product or service to a
6. The transaction price is the amount of consideration the company expects to receive in
exchange for transferring the goods or services. The following issues can complicate
7. The transaction price may need to be allocated to separate performance obligations using
one of the following methods:
8. A company satisfies its performance obligation when the customer obtains control of the
good or service. Indicators that the customer has obtained control include:
9. (L.O. 3) Other revenue recognition issues include:
a. Right of return
f. Warranties
10. (L.O. 4) In addition to contract assets and contract liabilities, companies disclose
qualitative and quantitative information about all of the following:
B. Revenue Recognition over Time
Revenue recognition during production: long-term construction contracts.
*1. (L.O. 5) Appendix 18-A. Percentage-of-completion method.
a. Gross profit is recognized periodically, based on the percentage of the job that is
2. (L.O. 6) Alternatively, if the criteria for recognition over time are not met, the company
recognizes revenues and gross profit at a point in time, that is, when the contract is
3. (L.O. 7) Accounting for losses on long-term contracts.
a. Recognize a loss in the current period on a profitable contract when costs
D. (L.O. 8) Appendix 18-B. Revenue Recognition for Franchises.
1. Franchises.
a. Discuss the nature of franchise agreements.
b. Discuss accounting for: