Revenue recognition under Generally Accepted Accounting Principles (GAAP) is a key accounting concept that outlines when and how a company should record revenue in its financial statements. It’s governed primarily by the Financial Accounting Standards Board (FASB) under ASC 606, “Revenue from Contracts with Customers,” which provides a standardized five-step model to ensure revenue is recognized accurately and consistently. Here’s a breakdown of the idea:
Core Principle
Revenue is recognized when a company satisfies a performance obligation by transferring control of a promised good or service to a customer. The amount recorded should reflect what the company expects to be entitled to in exchange for that good or service.
The Five-Step Model
- Identify the Contract with a Customer: A contract (written, oral, or implied) must exist, with enforceable rights and obligations. It needs to be approved, have identifiable payment terms, and be likely that the company will collect the consideration.
- Identify the Performance Obligations: Determine the distinct goods or services promised in the contract. A performance obligation is something the customer can benefit from on its own or with other readily available resources.
- Determine the Transaction Price: This is the amount the company expects to receive. It includes fixed amounts, variable considerations (like discounts or bonuses), and adjustments for the time value of money if payment is deferred significantly.
- Allocate the Transaction Price to Performance Obligations: If a contract has multiple performance obligations, the transaction price is divided among them based on their standalone selling prices.
- Recognize Revenue When (or As) Performance Obligations Are Satisfied: Revenue is recorded when control of the good or service transfers to the customer—either at a point in time (e.g., delivering a product) or over time (e.g., providing a service like a subscription).