Revenue Recognition (ASC 606)

Correct answer: A. Identify the contract with a customer; identify the performance obligations; determine the transaction price; allocate the transaction price to the performance obligations; recognize revenue when (or as) each performance obligation is satisfied

ASC 606-10-05-4 sets out the five-step model in this exact sequence: identify the contract with a customer, identify the performance obligations in the contract, determine the transaction price, allocate the transaction price to the performance obligations, and recognize revenue when or as the entity satisfies a performance obligation. The transaction price cannot be allocated in step four until the performance obligations from step two and the total price from step three both exist, so any ordering that determines price or allocates it before identifying obligations reverses a required dependency, which is why the second and fourth options are wrong. Recognizing revenue is deliberately the last step because it depends on knowing which amount was allocated to which obligation and whether that obligation has been satisfied, so placing recognition before allocation, as the third option does, skips a necessary input. Only the first option preserves the dependency chain the standard requires.

Source: FASB Accounting Standards Codification: ASC 606-10-05-4, Revenue from Contracts with Customers — Overview and Background

Correct answer: A. The contract has been reduced to a single, fully executed written document signed by both parties

ASC 606-10-25-1 requires that the parties have approved the contract and are committed to perform, that each party's rights to the goods or services can be identified, that payment terms can be identified, that the contract has commercial substance, and that collection of substantially all the consideration is probable — but nowhere does it require a single fully executed written document, because paragraph 606-10-25-2 explicitly allows contracts that are written, oral, or implied by an entity's customary business practices. The approval-and-commitment criterion, the identifiable-payment-terms criterion, and the collectibility criterion are each directly drawn from the standard's actual list, so each of those three options is a genuine requirement and cannot be the answer. Because a formal signed writing is not required for a valid contract under the standard, insisting on one is the criterion that does not belong on the list.

Source: FASB Accounting Standards Codification: ASC 606-10-25-1 and 606-10-25-2, Revenue from Contracts with Customers — Identifying the Contract

Correct answer: A. Whichever method the entity expects to better predict the amount of consideration to which it will be entitled, considering factors such as whether the contract has many similar possible outcomes or only two possible outcomes

ASC 606-10-32-8 does not mandate a single method for every variable-consideration arrangement; instead it directs an entity to use whichever of the two methods it expects will better predict the consideration it is entitled to, and it further explains that the expected value (a probability-weighted sum of possible amounts) tends to work best when a contract has a large number of similar outcomes, while the most likely amount tends to work best when a contract has only two possible outcomes, such as achieving or not achieving a bonus. Because the method is chosen based on predictive suitability rather than transaction type, the option requiring expected value for every rebate and the option requiring most likely amount for every variable arrangement are both wrong, as each ignores the standard's judgment-based test. The customer has no role in selecting the entity's estimation method, since this is an internal accounting judgment made by the reporting entity, not a contractual term negotiated with the counterparty.

Source: FASB Accounting Standards Codification: ASC 606-10-32-8, Revenue from Contracts with Customers — Estimating Variable Consideration

Correct answer: A. The entity is not required to adjust the promised amount of consideration for the effects of a significant financing component because the period between transfer of the goods and payment is one year or less

ASC 606-10-32-18 provides a practical expedient stating that an entity need not adjust the promised consideration for the effects of a significant financing component if, at contract inception, the entity expects the period between when it transfers a promised good or service and when the customer pays for it to be one year or less — and a 10-month gap falls within that one-year window, so no adjustment is required here. There is no blanket rule imputing interest after 30 days; the standard's expedient threshold is one year, not 30 days, so that option misstates the rule. The expedient is available based on the length of the payment period, not on the type of customer, so restricting it to government customers is not supported by the standard. Nothing in ASC 606 recharacterizes a sale-with-deferred-payment arrangement as a lease merely because payment follows delivery, since leases are governed by a separate standard (ASC 842) with its own recognition criteria.

Source: FASB Accounting Standards Codification: ASC 606-10-32-18, Revenue from Contracts with Customers — Significant Financing Component

Correct answer: A. The entity may recognize the $2,000 as an expense when incurred, because the amortization period of the asset it would otherwise have recognized is one year or less

ASC 340-40-25-4 offers a practical expedient allowing an entity to recognize the incremental costs of obtaining a contract, such as a sales commission, as an expense when incurred if the amortization period of the asset that would otherwise be recognized is one year or less, and a nine-month period qualifies. Capitalizing the commission over the customer's entire expected lifetime describes an approach relevant when commissions relate to anticipated renewals rather than a single short contract, not the short-amortization expedient itself, and it is not triggered simply by the contract being nine months long. Whether the underlying contract is cancellable is not the trigger for this expedient; the trigger is the length of the amortization period the incremental cost would otherwise be recognized over. The final option is also wrong because ASC 340-40 permits capitalization by default for incremental costs expected to be recovered; it is only this specific short-period expedient that additionally permits immediate expensing instead of capitalization.

Source: FASB Accounting Standards Codification: ASC 340-40-25-4, Other Assets and Deferred Costs — Contracts with Customers

Correct answer: A. As a contract liability, because the vendor has an obligation to transfer goods or services to the customer for which it has already received consideration

ASC 606-10-45-2 defines a contract liability as an entity's obligation to transfer goods or services to a customer for which the entity has already received consideration (or for which an amount is due) from the customer; receiving $12,000 before performing any of the annual service creates exactly this obligation, so it is recorded as a contract liability, not revenue. Revenue is recognized only when or as the entity satisfies its performance obligation by transferring control of the promised service, not merely upon receiving cash, so recognizing the full amount as revenue immediately would recognize revenue before it has been earned. A contract asset arises when an entity has already performed and transferred goods or services but its right to payment depends on something other than the passage of time — the opposite situation from receiving cash before performing any service. A receivable represents an unconditional right to consideration that the entity has already earned by performing, which also does not describe an advance payment received before performance has occurred.

Source: FASB Accounting Standards Codification: ASC 606-10-45-2, Revenue from Contracts with Customers — Contract Liabilities

Correct answer: A. Whether the customer can benefit from each good or service on its own or with readily available resources, AND whether the entity's promise to transfer each one is separately identifiable from the other promises in the contract

ASC 606-10-25-19 requires both criteria to be met before a promised good or service is distinct: it must be capable of being distinct (the customer can benefit from it on its own or together with readily available resources) and it must be distinct within the context of the contract (the entity's promise to transfer it is separately identifiable from other promises). In the scenario described, the significant customization integrates the installation with the equipment so that the vendor is really providing one combined output, which is exactly the kind of interdependence that fails the separately-identifiable half of the test even if the equipment alone could theoretically be used by another customer. Invoicing presentation and the timing of delivery are administrative or scheduling facts that the standard does not use to determine distinctness, so building the answer around a single invoice or a shared reporting period misapplies the test. ASC 606 also contains no dollar-threshold rule for this determination; the standard's guidance is entirely about the nature of the promises, not their combined price.

Source: FASB Accounting Standards Codification: ASC 606-10-25-19, Revenue from Contracts with Customers — Identifying Performance Obligations

Correct answer: A. The entity's performance does not create an asset with an alternative use to the entity, and the entity has an enforceable right to payment for performance completed to date

ASC 606-10-25-27 sets out three independent criteria, any one of which is sufficient for over-time recognition, and the facts given — no alternative use plus an enforceable right to payment for work performed to date — map directly onto the third criterion in the standard. The simultaneous-receipt-and-consumption criterion is a real alternative path under the same paragraph, but describing it as the only criterion the standard allows is wrong because the standard explicitly lists three separate, independently sufficient criteria, and the facts here actually illustrate the alternative-use-and-payment criterion instead. Legal title is expressly identified elsewhere in ASC 606 (606-10-25-30) as merely one indicator among several used to assess point-in-time transfer of control, not a standalone determinant of over-time recognition, so treating retained title as decisive misapplies the standard's structure. Whether a price is fixed or variable relates to determining the transaction price in step three of the model and has no bearing on which of the three over-time criteria in step five is met.

Source: FASB Accounting Standards Codification: ASC 606-10-25-27, Revenue from Contracts with Customers — Performance Obligations Satisfied Over Time

Correct answer: A. Include the estimated bonus in the transaction price only to the extent it is probable that a significant reversal of cumulative revenue will not occur when the uncertainty is resolved

ASC 606-10-32-11 constrains estimates of variable consideration so that an entity includes in the transaction price only the amount for which it is probable a significant revenue reversal will not occur in the future, and given the limited history and historically volatile outcomes described, the entity would need to constrain its estimate accordingly rather than include the full amount. Including the entire estimated bonus without regard to this probability assessment ignores the constraint the standard specifically imposes on volatile or poorly predictable variable amounts. Excluding all variable consideration until it is fully guaranteed goes further than the standard requires, since ASC 606 expects entities to estimate variable consideration using the expected value or most likely amount methods and then apply the constraint, rather than waiting for certainty. Waiting until cash is received to recognize revenue conflicts with the core recognition principle of ASC 606, which requires recognition when or as performance obligations are satisfied and the resulting consideration is estimated, not simply when cash changes hands.

Source: FASB Accounting Standards Codification: ASC 606-10-32-11, Revenue from Contracts with Customers — Constraining Estimates of Variable Consideration

Correct answer: A. As a separate contract, with the accounting for the original contract unaffected by the modification

ASC 606-10-25-12 requires a contract modification to be accounted for as a separate contract when it adds distinct goods or services and the price increases by an amount that reflects the standalone selling price of those additional goods or services, adjusted as appropriate for the circumstances — exactly the facts given here — and in that case the original contract's accounting is left unaffected. A cumulative catch-up adjustment is instead the approach used under ASC 606-10-25-13(b) when the modification is not treated as separate and the remaining goods or services are not distinct from those already transferred, which is not what these facts describe. Treating the modification as a termination of the old contract and creation of a new one describes the prospective approach under ASC 606-10-25-13(a), used when the remaining goods or services are distinct from those already provided but the additional goods are not priced at standalone selling price, which again does not match a modification priced exactly at standalone selling price. Because this modification qualifies as a separate contract, there is no basis for restating revenue already recognized under the original, unmodified contract.

Source: FASB Accounting Standards Codification: ASC 606-10-25-12 and 606-10-25-13, Revenue from Contracts with Customers — Contract Modifications

Correct answer: A. Because the marketplace does not control the specified good before it is transferred to the customer, and indicators such as the seller's fulfillment responsibility, inventory risk, and pricing discretion support that conclusion

ASC 606-10-55-36 makes control of the specified good or service before it transfers to the customer the determining factor for principal-versus-agent status, and 606-10-55-39 identifies fulfillment responsibility, inventory risk, and pricing discretion as indicators that support (rather than independently decide) that control assessment; here the seller holds all three indicators and the marketplace never controls the goods, so the marketplace is an agent recognizing only its net fee. Merely collecting and forwarding payment does not by itself make an entity an agent under the standard, since a principal can also use a payment collection mechanism while still controlling the underlying good — the standard looks to control of the good or service, not to who physically processes payment. The relative size of the fee compared to the total price is not a criterion in the standard at all, and a low fee percentage does not by itself indicate agent status. Where shipping originates from is only relevant to the extent it informs which control indicators are met; it is not on its own a dispositive test, since the standard directs entities to assess control using the underlying indicators rather than physical shipping logistics alone.

Source: FASB Accounting Standards Codification: ASC 606-10-55-36 through 606-10-55-40, Revenue from Contracts with Customers — Principal versus Agent Considerations

Correct answer: A. At the point in time the license period begins, because the film is functional intellectual property whose significant standalone functionality is not expected to substantively change during the license period

Under ASC 606's licensing implementation guidance, a completed media work such as a feature film is an example of functional intellectual property, meaning it has significant standalone functionality that is not expected to substantively change through the licensor's ongoing activities during the license term; a license to functional IP is recognized at the point in time the customer obtains the right to use it, which is when the license period begins. The claim that all IP licenses are recognized over time is incorrect because the standard explicitly distinguishes functional IP (generally point in time) from symbolic IP such as brands or trade names (generally over time, because the customer's ability to benefit depends on the licensor's continued supporting activities). Point-in-time recognition for functional IP does not depend on the customer separately purchasing maintenance; if maintenance or updates were a distinct promise, they would be identified and accounted for as their own separate performance obligation rather than changing how the license itself is classified. Retaining legal or copyright ownership is a feature of essentially all IP licenses, whether functional or symbolic, so it cannot be the basis for choosing over-time recognition; the standard instead focuses on whether the entity's ongoing activities significantly affect the IP the customer has rights to.

Source: FASB Accounting Standards Codification: ASC 606-10-55-59 through 606-10-55-65b, Revenue from Contracts with Customers — Licensing