Meaning
Revenue accounting follows a five step framework to ensure that financial statements depict the transfer of promised goods or services to customers. This standard, known as asc 606 compliance, governs how revenue from contracts is recognized over time or at a point in time. It stops applying once all performance obligations are met and the contract is terminated or completed.
Obligation Identification
Identification of performance obligations requires the separation of distinct goods from integrated services. This process within asc 606 compliance ensures that revenue is not pulled forward prematurely. If a license and a service are not distinct, they are bundled into a single unit for accounting purposes.
Transaction Allocation
Allocation of the total contract price occurs based on the standalone selling prices of each identified obligation. Discounts are spread proportionally across all items unless they specifically relate to a single piece of the deal. The math ensures that the timing of income matches the delivery of value to the client.
When prices are not observable, companies use an adjusted market assessment or expected cost plus margin approach to estimate the value.
Public Reporting
Disclosures for companies must provide qualitative data about the nature and timing of revenue. This reporting includes the description of judgment used in estimating variable consideration. Detailed reconciliations of contract balances are required to satisfy the audit trail and explain changes in assets and liabilities.
