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Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281

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Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281
Textbook Problem
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Prior to ASU 2014-09 changing the principles underlying revenue recognition, companies recognized revenue when it was earned and realized. The principles of earned and realized were replaced with a core principle which states that companies should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To accomplish this core principle, the FASB and the IASB stated that companies should follow a 5-step process.

Required:

Discuss the 5-step process that companies should use to accomplish the core principle of revenue recognition.

To determine

Explain the 5-step process used by companies to attain the core principle of revenue recognition.

Explanation

Revenue recognition principle:

Revenue recognition principle states that every business organization should recognize the revenue when it is earned, no matter, cash related to that obligation is received or not.

Following are the five criteria that should be met for a contract to be accounted for using the 5-step model in the revenue standard:

1. The “revenue recognition model” is applicable to those contracts that are approved by all parties either in a written form, orally or by implication. The company must be able to recognize the rights of each party with respect to goods and services transferred. The company must be able to recognize terms of payment with respect to goods and services transferred. This does not imply that the transaction price must be fixed or explicitly stated. In fact, the price of transaction can differ due to discount or rebates. The contract must have commercial substance which means that the contract should change the amount, timing or possibility of the company’s future cash flows. It must be possible for the company to collect the consideration to which it is entitled in “exchange for the goods or services” that will be transferred to the customer.

2. A contract must have a promise for “transferring goods and services” to a customer. In the revenue standard, a “performance obligation” is defined as a promise that is distinct. Recognizing “performance obligations” is straightforward, for example, Company S promises to deliver a cup of coffee. At times, it can be difficult to deliver the promise, for example, contract to provide a new accounting system with a 4-year software license, technical support and right to upgrades...

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