Accounting Standards for Revenue Recognition

That's not it. The revenue amounts recorded must be highly probable, so if there's any question, it shouldn't be recognized regardless of balance sheet equity account.

The __core principle__ of the new standards is that revenue is recognized as goods and services are transferred to customers in an amount that reflects the consideration the seller expects to receive. What do you think the word _consideration_ means in this context?

Incorrect. Thoughtfulness and respect is a definition of _consideration_ that is used in other contexts. The term in the core principle generally means the price of the product or service payable in the local currency. It could also mean delivery of goods or services in a barter contract. In short, it is the compensation the seller expects to receive in return for delivery of the products or services to the buyer.

Good! _Consideration_ generally means the price of the product or service payable in the local currency. It could also mean delivery of goods or services in a barter contract. In short, it is the compensation the seller expects to receive in return for delivery of the products or services to the buyer.

Consideration works the same in the newly converged standards, which involve a five-step process to apply the core principle. To illustrate, suppose that 100 shares of XYZ Corp. are purchased through a broker. 1. The first step is to identify the contract with the customer. There is a contract in XYZ's case since both parties have obligations as soon as the order for 100 shares is placed. 2. The second step is to identify the performance obligations of the contract. In this case, the brokerage has an obligation to deliver 100 shares to the client's account, and the client has an obligation to pay the broker for his or her services. 3. The third step is to determine the transaction price. Most brokerages have a fee based on number of shares transacted, so this is easy enough. 4. The fourth step is to allocate the transaction price to the performance obligations in the contract. (This is more relevant when more time-consuming projects are involved). 5. Finally, the fifth step is to recognize revenue as the entity satisfies a performance obligation. So based on your understanding of the five steps, when do you think the revenue should be recognized in the scenario involving XYZ Corp.?

Correct. Based on the fifth step, revenue can be recognized _after_ the parties have satisfied their performance obligations. The performance obligation of the broker will be satisfied after the shares have been obtained for the client. The client also has a performance obligation to pay for the services. So after the shares are obtained in the market and placed in the clients account, the client then pays for the services with cash, or more likely a credit card. That is when revenue can be recognized.

Incorrect. At this point, the parties haven't yet fulfilled their performance obligations, so revenue isn't recognized. According to the fifth step, the performance obligation of the broker will be satisfied _after_ the shares have been obtained for the client. The client also has a performance obligation to pay for the services. So after the shares are obtained in the market and placed in the client's account, the client then pays for the services with cash, or more likely a credit card. That is when revenue can be recognized.

Now, of course, most situations in the real world are going to be more complex, but even so, the same core principle and five steps apply, no matter the complexity. One such complex situation, for example, might be where performance is completed over time, like in a construction contract for a building. The fourth step states that the transaction price is allocated to the performance obligations. Applying this rule, the transaction price needs to be allocated over the years of the contract for revenue recognition purposes. This is measured by the percent of the total estimated costs incurred. Suppose, for instance, that the estimated total costs for the construction project are EUR 1.5 million, and EUR 0.5 million are incurred in Year 1. How much revenue do you think would be recognized in Year 1, according to the new accounting standards?

Incorrect. All of the revenue would not be recognized in Year 1, as the performance obligations would not yet be complete. Because you are measuring how much was completed by percent of costs incurred, only one-third of the revenue is recognized in Year 1, since one-third of the costs were incurred.

Correct. Because you are measuring how much was completed by percent of costs incurred, only one-third of the revenue is recognized in Year 1, since one-third of the costs were incurred. All of the revenue would not be recognized in Year 1, as the performance obligations would not yet be complete.

In summary: [[summary]]

Essentially, revenue should only be recognized when it is highly probable that it will not be subsequently reversed. This may result in a minimal amount of revenue recorded when an estimate of total revenue isn't reliable. And this impacts the balance sheet. For example, an asset will need to be booked for the right to return goods based on the carrying amount of inventory less costs of recovery. But there needs to be an additional entry. What additional entry should be used to offset the asset recorded?

No. The revenue amount that could be recognized as already been recorded, so it's not double recorded in equity.

That's right! Revenue must be highly probable so if it's not, then an asset is booked and an offsetting liability transaction is recorded that reflects the entire refund obligation. So it's only at the moment when all performance obligations are met except for payment that a receivable appears on the seller's balance sheet. If consideration is received before the good or service is transferred, the seller presents a contract liability. In order to determine when the customer has obtained control of the asset, there are five considerations. The entity has a right to payment, customer has legal title, customer has physical possession, customer carries significant risks/rewards of ownership, and customer has accepted the asset.

Convergence between US GAAP and IFRS has long been desired by users of financial statements, particularly because it allows users to compare financial data from different countries. One of the biggest areas where US GAAP and IFRS traditionally differed was revenue recognition. But this problem was solved in 2018 when new, converged standards took effect.

Think back to the building example. Contracts like this one often change as time goes on. The floor plans may be modified, or the estimated time to completion may change. The new standards define changes like these as a new contract if the change results in new products or services being delivered. In a situation like this, where the building is already in progress, it is defined as a modification in the new standards. The total revenue and costs must be recalculated to reflect the changes, and the proportion of completion calculated. A cumulative catch-up adjustment is required. Another area where the new standards differ is related costs. The incremental costs of obtaining a contract and certain other costs now need to be capitalized and added to the building asset rather than expensing them when incurred. Disclosure requirements are also quite detailed, something most financial statement users will appreciate. For clarity, contracts need to be split up and disclosed by type and geographic area similar to business segment data.

Thoughtfulness and respect

The price the seller is to receive

When the shares are delivered to the client and the client is billed

When the shares are ordered and the parties agree to the consideration

All of it

One-third of it

A revenue amount recorded in equity

A refund obligation recorded in liabilities

A revenue amount recorded in other comprehensive income

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