Another recap. Revenues are inflows of enhancements of assets or settlements of liabilities, which constitute the central ongoing operations, once determined by “when” and “how much” under the realization principle, and now, the Core Principle, under the “Contracts with Customers” standard. With the new standard and principle, Revenue recognition is more aligned to FASB’s conceptual framework, is more uniform across industries, and helps with more complex arrangements. No longer is it a “earnings virtually complete” or “collections reasonably certain” criterion. And the five steps to the “Contracts with Customers” standard are identifying the contract, in which a contract can be implicit, explicit, written, or oral and must have commercial substance, must be approved, rights are specified, repayment terms have been determined, and probable that customer will collect (contract must have performance obligation and penalty if not performed). And a customer is said to own a good if obligation to pay exists, legal title exists, physical possession exists, rights and rewards are transferred, and terms are accepted.
The second step is identifying the performance obligation, and if it is multiple, whether the performance obligation is capable of being unique and separately identifiable. Performance Obligations extend to “Extended Warranties” and Options, but not to prepayments, quality insurance, and right to returns. The third step is determining the transaction price. This is inclusive of whether there is a principal or an agent, to help identify if there is a recording of gross or net revenue. And in this step, we must consider variable consideration, and how probable revenue is to NOT be overturned. Indicators that variable consideration and revenue can be overturn include Poor Evidence, Outside Sellers Control, History, broad range of outcomes, and long delays in resolutions. Methods of calculating this type of transaction is “Expected Value” or “Most Likely Amount” Methods.
The fourth step is allocating transaction type and the fifth step is recognizing revenue when the performance obligation has been satisfied. In allocating the transaction type OR finding the STAND ALONE SELLING PRICES, approaches to consider are Adjusted Market Assessment, Expected Cost Plus Margin, and Residual. So, if you are considering a bundled price of two products at $200 and one product stand alone is $150 and the other is $100, then the first product will constitute 60% of the 200 being $120 and the second product will make up the other 40% or $80. And as we move on, the Adjusted Market Assessment approach takes the price of the product/service if it were sold in the market today.
Expected Cost Plus Margin Approach will calculate a cost for performing the performance obligation and then add a profit margin on top of that. And Residual Approach will subtract the known estimated “Stand Alone Selling Prices” of other products/service and then find the total transaction price. Therefore, under the Residual approach, if a full-on subscription is worth $200, and the stand along tangible product is $150, then the estimated subscription price is $50. Here you will defer the revenue (credit liability account) by the $50, until services have been rendered. Knowing Step 4 is Step 9.