Revenue is recognized based on a five-step process that is applied to a company’s revenue arrangements.
Answer the following questions in the Discussion Board:
- Briefly describe the five-step process.
- Explain the importance of contracts when analyzing revenue arrangements.
- How are fair value measurement concepts applied in implementation of the five-step process?
- How does the five-step process reflect application of the definitions of assets and liabilities?
Kieso, D. E., Weygandt, J. J., & Warfield, T. D. (2016). Financial accounting and accounting standards. Intermediate accounting (16th ed.). (p. 1047). New York, NY: John Wiley & Sons, Inc.
Just do response each posted # 1 to 3 down below.
The five steps of recognizing revenue are: identifying the contract with customer, identifying the separate performance obligations in the contract, determine the price, allocate the transaction price to the separate performance obligations, and recognize revenue when the contract obligations are complete.
Contracts are important because they give the detail of what is required from each party involved. As long as everything is written out completely in the contract each party has to follow through with what their obligation is to the other. Whether is it to do with a service/product or money owed.
There are instances where the companies are not paid in cash, but rather with a good, service, or non-cash considerations. When there is not actual cash that is being exchanged the company would then have to recognize the revenue at the fair value of what is received at the time.
The assets and liabilities are applied when the companies recognize revenue. When a company would deliver a service or a product it then has the “right to consideration” meaning that the contract in this case would be an asset. If the company receives the money before the product or service is delivered then the contract becomes a liability on the sellers part. These must be shown correctly on the companies financial statements.
a/ Revenue is recognized when goods or services have completely provided or performed. (Kieso, Weygant & Warfield, 2016, p. 981). There are five basic steps in revenue recognition. First, the entity needs to “identify the contract” where two or more associated parties agree with each other to the arrangement. Next, each performance obligation has to be identified and accounted for separately when there is more than one in the same contract. Then, figuring the expected receiving price from the customer to record appropriately. After that, if there are interrelated performance obligations, the price for each needs to be allocated and separated among each other; and each individual price could base on the standalone basis. Finally, when the performance is completed and satisfied, revenue is recognized in the correct accounting period.
b/ Contracts are important in a business environment. Contracts could be between a business and a business or individuals. A company analyzes contracts with customers to obtain revenue transactions. Contracts specify the agreement between parties and must be met by each party.
c/ Fair value is used to measure and apply in the five-step process of revenue recognition when there is noncash consideration. There is a situation when the two parties agree to exchange goods with goods or services, the company based on the basis of fair market value of what is received to record the transactions.
d/ “Company use an asset-liability approach to recognize revenue.” (Kieso, Weygant & Warfield, 2016, p. 1007). In other words, a company receives revenue based on the asset or liability coming from contracts with customers. When having contract assets with conditional rights, the company will only receive payment for one with a condition of completing the other. For example, if the contract has two separate obligations: A & B, in order to receive payment for A, the company has to complete the B as well.
The five step process consists of: Identify the contract with customers, Identify the separate performance obligations in the contract, Determine the transaction price, Allocate the transaction price to the separate performance obligations, Recognize revenue when each performance obligation is satisfied. (Kieso, Weygant & Warfield, 2016)
Contracts are important because it is where all of the details of an arrangement are laid out. It spells out exactly what each party involved must complete, the time it should take to complete, and what money is due once services have been rendered if any.
Companies receive consideration in the form of goods, services, or other noncash consideration. When these situations occur, companies generally recognize revenue on the basis of the fair value of what is received. (Kieso, Weygant & Warfield, 2016)
Companies use an asset-liability model to recognize revenue. For example, when a company delivers a product (satisfying its performance obligation), it has a right to consideration and therefore has a contract asset. If, on the other hand, the customer performs first, by prepaying, the seller has a contract liability. Companies must present these contract assets and contract liabilities on their statement of financial position.