06. Revenue Recognition: Core Principles and Applications

By Jay

🔑 Key Concept: 5-Step Model: I am a STAR

ASC 606 provides a unified model for recognizing revenue from contracts with customers.

✅ Step 1: Identify the Contract

  • A contract is an agreement between two or more parties that creates enforceable rights and obligations.
  • Criteria include: approval, identification of rights and payment terms, commercial substance, and collectibility.
  • Revenue when job is done

✅ Step 2: Identify the Seperate Performance Obligations

  • A performance obligation is a promise to transfer a distinct good or service.
  • If goods/services are not distinct, they are combined.

✅ Step 3: Determine the Transaction Price

  • Consider variable consideration, time value of money, noncash consideration, and consideration payable to the customer.

✅ Step 4: Allocate the Transaction Price

  • Allocate based on standalone selling prices of each performance obligation.

✅ Step 5: Recognize Revenue

  • Revenue is recognized when (or as) the performance obligation is satisfied.
  • Over time (e.g., services), or at a point in time (e.g., product delivery).

🧾 Common Journal Entries

At contract inception (no entry unless cash is received)

Dr. Cash or A/R  
   Cr. Unearned Revenue (if received before delivery)

When revenue is recognized

Dr. Unearned Revenue (if deferred)  
Dr. Cash or A/R (if not yet received)  
   Cr. Revenue

🧠 Notes

  • Incremental costs of obtaining a contract (e.g., sales commissions) are capitalized if expected to be recovered.
  • Contract asset: performance obligation is satisfied, but not yet billed.
  • Contract liability: customer pays in advance, but goods/services not delivered yet.

🔍 Practice Questions

Q1:

A company enters into a contract to sell 1,000 units of a product for $10 each. The product is delivered over 5 months. How much revenue is recognized each month?

Answer: $2,000 per month
Explanation: $10,000 total / 5 months = $2,000 per month (assuming equal delivery and satisfaction of performance obligations).

Q2:

A company receives $12,000 in advance for a 12-month subscription service. What is the journal entry after receiving cash, and then after one month?

Initial Entry:

Dr. Cash $12,000  
   Cr. Unearned Revenue $12,000

After One Month:

Dr. Unearned Revenue $1,000  
   Cr. Revenue $1,000