CHAPTER 5 Revenue Recognition and Profitability Analysis 303 Illustration 5–A1 Some Important Changes in Revenue Recognition GAAP Resulting from ASU No. 2014-09 Previous GAAP New GAAP Under ASU No. 2014-09 conclude with coverage of revenue recognition practices particular to software contracts, other multiple-deliverable arrangements, and franchises. The Realization Principle Revenue recognition used to be based on the realization principle . As shown in Illustration 5–A2 , the realization principle required that two criteria be satisfied before revenue can be recognized (recorded). The realization principle may sound similar to the approach discussed in Chapter 5, which bases revenue recognition on satisfaction of performance obligations and which requires that it be probable that receivables will be collected. However, it differs in important ways. First, the idea of completion of the earnings process was interpreted and applied differently in various industries and for various types of products and services. As a consequence, revenue recognition standards and other guidance became very complicated, and sometimes transactions that were relatively similar were treated very differently. The ASU eliminates The realization principle bases revenue recognition on completion of the earnings process and reasonable certainty about collectibility. Key concept underlying revenue recognition The realization principle: Recognize revenue when both the earnings process is complete and there is reasonable certainty as to collectibility of the asset(s) to be received. The core revenue recognition principle: Recognize revenue when goods or services are transferred to customers for the amount the company expects to be entitled to receive in exchange for those goods and services. Role of collectibility in determining whether revenue is recognized. Defer revenue recognition if cash collection is not reasonably certain. Use installment method or cost-recovery method to tie revenue recognition to subsequent cash collection. Defer revenue recognition until cash collection is probable. Installment and costrecovery methods eliminated. Criteria for recognizing revenue over time Depends on the earnings process. For long-term contracts, recognizing revenue over time is generally required unless reliable estimates can’t be made. Depends on characteristics of the contract and of the performance obligations being satisfied. Accounting for multiple performance obligations Depends on the industry. Sometimes performance obligations are ignored (e.g., “free” smartphones in cell phone contracts); sometimes revenue recognition is constrained (e.g., software for which there is not sufficient evidence of stand-alone prices). Regardless of industry, apply criteria for determining whether goods and services are distinct to identify performance obligations, allocate transaction price to performance obligations, and recognize revenue when each performance obligation is satisfied. Treatment of customer options for additional goods or services Depends on the industry. Sometimes treated as a separate deliverable (e.g., software upgrades), other times ignored (e.g., frequent flyer miles). Regardless of industry, treat an option as a separate performance obligation if it provides a material right to the customer that the customer would not otherwise have. Treatment of variable consideration Typically only recognize revenue associated with variable consideration when uncertainty has been resolved. Include estimated variable consideration in the transaction price, but only to the extent it is probable that a significant revenue reversal will not occur in the future. Treatment of time value of money Interest revenue recognized for long-term receivables but interest expense typically not recognized for long-term customer prepayments. Interest revenue or expense recognized for both long-term receivables and longterm customer prepayments if amount is significant.
Spiceland_Inter_Accounting8e_Ch05
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