Step 10 of 10 in Knowing Revenues

We made it to the last step. So, what do we know so far. Well, revenues are inflows of enhancement of assets or settlements of liabilities. They constitute as the central ongoing source of operations, once determined by the “when” and “how much” by the Realization Principal, replaced for a better Core Principal, under the “Contracts with Customers” standard. Realization Principal used to determine earnings by whether they were “virtually complete” and if the collections were “reasonably certain”. But it failed to align well with FASB’s Conceptual Framework, did not provide uniformity across industries, and it wasn’t efficient in handling complex arrangements. With this said, the new, “Contracts with Customers” standard fixes that, by applying five steps being, identifying the contract, identifying the performance obligation, determining the transaction price, allocating the transaction price, and then recognizing the revenue when the performance obligation is satisfied.
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In the first step, identifying a written, oral, implicit, or explicit contract must have Commercial Substance, must be approved by parties, must have the rights specified, repayment terms must be determined, and it is probable the customer will collect (meaning the contract will have to state performance obligations and a penalty for not fulfilling it). A customer is said to own the good if the obligation to pay exists, legal title exists, physical possession exists, right and rewards have been transferred, and good has been accepted.
 
In the second step, which is identifying performance obligation, the obligation must be capable of being unique and separately identifiable. Performance obligations include Extended Warranties and Options, but exclude Prepayments, Quality Assurance, and Right for Returns (given that those three are requisites to fulfilling the initial performance obligation). Account properly for those performance obligations, i.e. the extended warranties or options (i.e. discounts).
 
The third step is determining the transaction price. Transaction price implications consider a principal and agent dynamic (principal record revenue on a gross revenue basis and agent records on a net revenue basis), variable consideration, which shows that revenues will not be overturned. You will not have a variable consideration if there is Poor Evidence, Control Outside the Seller, History, Broad Range of Potential Outcomes, and Long Delays in Resolution. Potential ways to calculate these variable considerations (i.e. a performance bonus clause) includes the “Expected Value” and “Most Likely Amount” Methods.
 
The forth step is allocating the transaction type or determining standalone prices for products/services. In allocating the transaction type, there are Three Approaches, in determining the allocation type. You have the Adjusted Market Assessment (if it were sold in the market today), the Expected Cost-Plus Margin Approach (taking the cost of performing the obligation and adding a profit margin), and then the Residual Approach (taking a total determined price and then subtracting a known estimated stand-alone prices for the variable considerations).
 
The fifth step is recognizing the revenue when the performance obligation has been satisfied. Important topics to consider in this step are revenue recognition in consignment arrangements. First thing to know about this, cosigner assumes risk of ownership and will postpone revenue recognition until a sale of a third party has occurred. Cosigners will have to physically transfer goods to the consignee, but the cosigner will retain legal title. To move forward, consignee will have to pay the necessary selling price, but if the consignee does not find a buyer, consignee will have to return the goods to the cosigner. Last consideration in this step is dealing with gift cards. Gift Cards by nature are deferred revenue liabilities (where the debit of the credit comes in the form of cash), and once a gift card is redeemed or expired, only then, may the individual recognize a gift card (and credit it) as revenue. Knowing Step 5 is Step 10.