Accounting resources for ASC 606 and IFRS 15

Need help accounting for revenue recognition under U.S. GAAP or IFRS? Well, you’ve come to the right place! We’ve published this accounting topic page to help you learn more about the revenue recognition, including accounting issues and GAAP differences. We also provide helpful links to our blog posts and eLearning courses on the topic. It’s a smorgasbord of ASC 606 and IFRS 15 knowledge all in one convenient location!

The core principle of recognizing revenue is that an entity recognizes 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.

ASC 606 and IFRS 15, both titled Revenue from Contracts with Customers, prescribes a 5-step model entities should follow in order to recognize revenue in accordance with the core principle. These five steps for accounting for revenue recognition are:

1. Identify the contract(s) with a customer
2. Identify the performance obligations in the contract
3. Determine the transaction price
4. Allocate the transaction price to the performance obligations in the contract
5. Recognize revenue when (or as) the entity satisfied the performance obligations

Welcome video

Accounting issues

The 5-step model within IFRS 15 and ASC 606 applies to ALL contracts with customers, regardless of industry, unless the contract is within the scope of other guidance (for example, leases within the scope of ASC 842).

In this section, we’ll walk through each of the 5 steps that must be applied to recognize revenue arising from a contract with a customer and focus on a few of the application issues with more widespread relevance across industries and transactions.

Step 1: Identify the contract(s) with a customer

Overview of step 1

A contract is an agreement between two or more parties that creates enforceable rights and obligations. Enforceability of the rights and obligations in a contract is a matter of law. Contracts can be written, oral, or implied by an entity’s customary business practices.

An entity should account for a contract with a customer that is within the scope of ASC 606 only when all of the following criteria are met:

1. The parties to the contract have approved the contract and are committed to perform their respective obligations.
2. The entity can identify each party’s rights regarding the goods or services to be transferred.
3. The entity can identify the payment terms for the goods or services to be transferred.
4. The contract has commercial substance.
5. It is probable that the entity will collect the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer.

If an arrangement fails to meet all of these criteria at contract inception, it does not qualify as a contract, and no revenue should be recognized under either ASC 606 or IFRS 15. The entity should continue to re-evaluate these criteria each reporting period until the contract meets the criteria.

Accounting issue: Change in collectibility of a contract

While step 1 seems fairly straightforward, sometimes its application can pose a challenge. One aspect of identifying a contract is to ensure it is probable (or highly probable under IFRS) that the entity will collect substantially all of the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer. If collectability is not probable, then you don’t really have a contract and no revenue should be recognized.

What happens if a contract is deemed collectible at contract inception, but subsequently, perhaps even years after the contract was established, collectibility is no longer probable?

If a contract with a customer meets the criteria in Step 1 at contract inception, an entity does not reassess those criteria unless there is an indication of a significant change in facts and circumstances. The assessment of whether a significant change in facts and circumstances occurred is situation-specific and often a matter of judgment. If such a significant change does occur, and collectibility is no longer probable, the entity is precluded from recognizing additional revenue under the contract until collectibility again becomes probable or the entity receives nonrefundable consideration and other criteria are met (e.g., performance has been completed, the contract is terminated, etc.).

Step 2: Identify performance obligations

Overview of step 2

According to ASC 606 and IFRS 15, a performance obligation is a promise in a contract with a customer to transfer to the customer either:

1. A good or service (or bundle of goods or services) that is distinct, or
2. A series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer.

A good or service that is promised to a customer is distinct if both of the following criteria are met:

1. The customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer.
2. The entity’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract.

If a promised good or service is not distinct, an entity combines that good or service with other promised goods or services until it identifies a bundle of goods or services that is distinct. In some cases, all the goods or services promised in a contract would be treated as a single performance obligation.

Generally, a contract with a customer explicitly states the goods or services that an entity has promised to a customer, but not always. This is because a contract with a customer may also include promises that are implied by an entity’s customary business practices, published policies, or specific statements. If, at the time of entering the contract, those promises create a valid expectation of the customer that the entity will transfer a good or service to a customer, these promises could also be performance obligations. However, performance obligations do not include activities that an entity must undertake to fulfill a contract, unless those activities transfer a good or service to a customer.

Accounting issue: Warranties

ASC 606 and IFRS 15 introduce two types of warranties: service-type warranties and assurance-type warranties.

Service-type warranties

If the customer has the option to purchase the warranty separately or if the warranty provides a service to the customer beyond fixing defects that existed at the time of sale, the entity is providing a service-type warranty. The Boards determined that this type of warranty represents a distinct service and is a separate performance obligation. Therefore, the entity allocates a portion of the transaction price to the service-type warranty based on the estimated standalone selling price of the warranty. The entity then recognizes revenue allocated to this type of warranty over the period the warranty service is provided.

Assurance-type warranties

The Boards concluded that assurance-type warranties do not provide an additional good or service to the customer (i.e., not a separate performance obligation). By providing this type of warranty, the selling entity has effectively provided a guarantee of quality. Under the standard, these types of warranties are accounted for as warranty obligations, and the estimated cost of satisfying them is accrued in accordance with other relevant guidance.

Certain arrangements may include both an assurance-type warranty and a service-type warranty. However, if an entity provides both an assurance-type and service-type warranty within an arrangement and the entity cannot reasonably account for them separately, the warranties are accounted for as a single performance obligation (i.e., revenue would be allocated to the combined warranty and recognized over the period the warranty services are provided). When an assurance-type warranty and a service-type warranty can be accounted for separately, an entity is required to accrue for the expected costs associated with the assurance-type warranty and defer the revenue for the service-type warranty.

Step 3: Determine the transaction price

Overview of step 3

In step 3, we determine the amount the entity expects to receive for satisfying the performance obligations in revenue contracts with customers. This transaction price may include fixed amounts set forth in the contract, variable amounts, or both. It might also include adjustments for significant financing arrangements (i.e., time value of money) or the fair value of any non-cash consideration received.

Variable consideration is very broadly defined and can be either explicitly or implicitly set forth in the contract. Variability takes many forms and includes discounts, rebates, customer incentives, refunds, credits, performance bonuses, penalties, contingencies, and price concessions.

To estimate variable consideration, entities use one of two methods and apply the method consistently throughout the term of the contract:

• Expected value: the sum of an entity’s probability-weighted estimates
• Most likely amount: the amount with the highest likelihood of occurrence in a range of possibilities

When estimating variable consideration, entities should only include amounts they are likely to realize and, therefore, not subject to significant revenue reversal (sometimes referred to as the “revenue constraint”). In making this determination, entities need to consider factors that might increase the chances of revenue reversal.

Accounting issue: Significant financing component

The guidance states that time value of money is reflected in a vendor’s estimate of the transaction price if the contract has a financing component that is significant to the contract using the discount rate that would be reflected in a separate financing transaction between the vendor and the customer at the inception of the contract. Any financing component is recognized as interest expense (when the customer pays in advance) or interest income (when the customer pays in arrears). An entity should consider all relevant facts and circumstances in assessing whether a contract contains a financing component and whether that financing component is significant to the contract. If so, financing component must be presented separately.

This might seem counterintuitive, but a practical way to look at it is that the customer provided the vendor with financing that it would otherwise have had to obtain from another party, thus incurring interest expense. In order to account for this, revenue is “grossed up” using the same discount rate that the vendor would use if it were to enter into a separate financing transaction with the customer. Interest expense is then recognized over time.

There is also practical expedient whereby time value of money can be ignored for periods that are one year or less.

Step 4: Allocate the transaction price to the performance obligations

Overview of step 4

The whole objective of step 4 is to allocate the transaction price to the various performance obligations identified in step 2 so that we can recognize a reasonable amount of revenue when those performance obligations are satisfied. This allocation is referred to as the relative standalone selling price approach.

At a high level, the standalone selling price is the price at which an entity would sell a promised good or service separately to a customer. The best evidence of this standalone price is the observable price of a good or service when the entity actually sells that good or service separately in similar transactions. Although contract prices may represent the standalone selling price of that good or service, this is not always the case.

Oftentimes, actual standalone selling prices do not exist, and entities must use an estimation method in order to properly allocate the transaction price. This estimation should always seek to maximize observable inputs, and estimation methods may include:

• An adjusted market assessment approach,
• An expected cost plus a margin approach; or
• A residual approach (but only in limited circumstances).

Accounting issue: Allocation of discounts to the various performance obligations

Normally, an entity allocates any discounts, proportionately, to all the performance obligations in the contracts. However, if an entity has observable evidence the entire discount relates to just certain performance obligations, then the entity allocates a discount entirely to one or more, but not all, performance obligations in the contract, assuming all of the following criteria are met:

1. The entity regularly sells each distinct good or service (or each bundle of distinct goods or services) in the contract on a standalone basis.
2. The entity also regularly sells on a standalone basis a bundle (or bundles) of some of those distinct goods or services at a discount to the standalone selling prices of the goods or services in each bundle.
3. The discount attributable to each bundle of goods or services described above in (b) is substantially the same as the discount in the contract, and an analysis of the goods or services in each bundle provides observable evidence of the performance obligation (or performance obligations) to which the entire discount in the contract belongs.

If a discount is allocated entirely to one or more performance obligations in the contract, an entity allocates the discount before using the residual approach to estimate the standalone selling price of a good or service

Step 5: Recognize revenue

Overview of step 5

We have now reached the culmination of the 5-step model. At this point, entities need to determine the timing of their revenue recognition, which should be based on when control of the underlying good or service is transferred to the customer. Control in this context refers to the ability to:

1. Direct the use of, and obtain substantially all the benefits from, an asset (i.e., the asset’s potential indirect or direct cash flows), OR
2. Prevent other entities from directing the use of, and obtaining the benefits from, an asset.

Based on the nature of a revenue contract, customers may obtain control of the related asset either over time or at a point in time. But this is not a choice. You have to EARN revenue recognition over time by meeting one of the following criteria:

If control transfers over time, an entity will recognize revenue over the period it satisfies the related performance obligation utilizing a method (i.e., input or output method) that best depicts the progression toward satisfying the performance obligation. Think the percentage-of-completion method used by construction companies. Regardless of what method they choose, entities need to apply the method consistently to similar performance obligations and in similar transactions or arrangements.

When control does not transfer over time, entities must determine the point in time in which control of the underlying asset transfers to a customer based on the applicable facts and circumstances.

Accounting issue: Recognizing revenue gross as principal or net as agent

Determining whether revenue should be recognized gross as the principal or net as an agent is a “hot topic” with accountants and auditors alike. Why? Because if you get it wrong, your income statement can be grossly overstated or understated with respect to the revenue that is reported. So, getting it right is very important, although it can require a significant amount of judgment.

One of the keys to determining whether an entity is a principal or agent in a transaction is to determine the nature of its promise to the customer, which includes considering:

1. Identifying the specified goods or services to be provided to the customer; and
2. Assessing whether it controls each specified good or service before that good or service is transferred
   to the customer.

An entity is a principal if it controls the specified good or service before that good or service is transferred to a customer. If an entity is a principal, it presents revenue and cost of sales on a gross basis. Alternatively, if an entity does not control the good or service before it is transferred to the customer, the entity is an agent in the transaction. Agents present revenue net of the related cost of sales in the income statement. In other words, agents basically only report their “commission” as revenue.

Control is defined within step 5 and refers to the ability to direct the issue of, and obtain substantially all the remaining benefits from, the asset. However, it is not always clear whether a customer obtains control of the specified good or service. Luckily, ASC 606 and IFRS 15 provided the following three indicators of control that can be useful in determining who is the principal in the transaction:

1. The entity is primarily responsible for fulfilling the promise to provide the specified good or service.
2. The entity has inventory risk before the specified good or service has been transferred to a customer, or after transfer of control to the customer (for example, if the customer has a right of return).
3. The entity has discretion in establishing the prices for the specified good or service.

Accounting differences: ASC 606 vs. IFRS 15

While ASC 606 and IFRS 15 are mostly converged, there still are a few differences which arose when the FASB issued a string of ASUs after both Boards issued their final standards. Although this is not an all-inclusive list, here are the top differences between U.S. GAAP and IFRS related to revenue:

Online learning

Looking for additional training on the accounting for revenue recognition under U.S. GAAP or IFRS? Look no further than our interactive eLearning courses available on the GAAP Dynamics Learning Library. For over 20 years we’ve helped some of the largest accounting firms and companies in the world understand complex accounting and auditing standards, and we can help you too!

Accounting for revenue recognition under U.S. GAAP (ASC 606)

Below are the courses we have available related the accounting for revenue recognition under U.S. GAAP:

Revenue: Overview of ASC 606 (1.0 CPE) – ASC 606 Revenue from Contracts with Customers provides a comprehensive revenue recognition model that applies to a wide range of transactions in all industries. In this CPE-eligible, eLearning course we look at the core principle of ASC 606 and provide an overview of the revenue recognition requirements in U.S. GAAP. You learn about the 5-step model for recognizing revenue found within ASC 606 by going through each step, and then have a chance to apply what you’ve learned by completing a comprehensive case study. If you’re new to accounting for revenue under U.S. GAAP, this online course is for you! In subsequent online courses, we dive into the details of each of the steps within the 5-step model prescribed by ASC 606.

Revenue: Specific Issues (1.0 CPE) – Now that you have a good understanding of accounting for revenue recognition in accordance with U.S. GAAP and the 5-step model found within ASC 606 Revenue from Contracts with Customers, it’s time to dive into some specific issues associated with the revenue recognition standard. Do you know how to identify a material right in a contract? What about identifying whether you are a principal or an agent? How about accounting for contract modifications? This CPE-eligible, eLearning course has you covered, answering those questions and more! This online course also covers other practical application issues associated with the 5-step model such as accounting for warranties and right of return.

We’ve recently released a course for each step in the ASC 606 5-step model:

• Revenue: Identify the Contract with the Customer (Step 1 of ASC 606) (0.5 CPE) 
• Revenue: Identify Performance Obligations (Step 2 of ASC 606) (0.5 CPE) 
• Revenue: Determine the Transaction Price (Step 3 of ASC 606) (1.0 CPE) 
• Revenue: Allocate Transaction Price (Step 4 of ASC 606) (0.5 CPE) 
• Revenue: Recognize Revenue (Step 5 of ASC 606) (1.0 CPE) 

If you’re looking to take all of these courses (and save a substantial amount of money), be sure to check out our ASC 606: Revenue from Contracts with Customers eLearning course collection for big savings!

Accounting for revenue recognition under IFRS (IFRS 15)

Revenue: Overview of IFRS 15 (1.5 CPE) – Revenue is one of the most important line items in a set of IFRS financial statements. As such, it is important to get the accounting right! IFRS 15, Revenue from Contracts with Customers is your one-stop shop for revenue accounting for all companies, regardless of their industry. This CPE-eligible, eLearning course walks through the key concepts of the 5-step model within IFRS 15, step by step, and gives you an opportunity to apply what you’ve learned in practice using examples and class discussion questions!

Accounting Resources

Step-by-Step Guide to Revenue Recognition (ASC 606)

Our guide walks you through each step of the 5-step model within ASC 606 Revenue from Contracts with Customers. It provides you with a high level overview of the requirements using various microlearning training modules.

In addition, we’ve written several blog posts on a variety of topics related to accounting for revenue recognition. Click on the links below to learn more.

Blogs: General guidance

This series of posts examines each step in the five-step revenue recognition model. Each step includes a series of practical examples or questions that reviews the proper accounting under the old standard and highlights how the answer will change under the new standard.

1. Step 1– Identify the contract
2. Step 2– Determine the Performance Obligations
3. Step 3– Determine the Transaction Price
4. Step 4– Allocate the Transaction Price to the Performance Obligations
5. Step 5– Recognize Revenue

Don’t Be A Control Freak! Revenue Recognition Criteria (ASC 606 and IFRS 15)
Who gets into a disagreement with a prospective client about application of accounting at a trade booth? Me, that’s who! But I had a good reason. She was misinterpreting the revenue recognition criteria under U.S. GAAP and IFRS (ASC 606 and IFRS 15) and I had to save her from herself (and her auditors). This post explores the concept of control within the new standards.

Blogs: Specific Issues

Principal vs. Agent? GAAP Revenue Recognition Criteria (ASC 606) 
Should you report revenue gross as a principal or net as an agent? Using a “real-life” example, this post explores the new revenue recognition criteria related to principal vs agent determination under ASC 606.

Gunga Galunga: Accounting for Nonrefundable Initiation Fees under ASC 606
I’m eating lunch at a dive bar in the Himalayas and who sits down to eat with me? The Dalai Lama himself. Twelfth son of the Lama. The flowing robes, the grace, bald…striking. So, we order our lunch – big eater, the Lama – and, as he’s wolfing down his yak tacos, he asks me about the accounting for upfront, nonrefundable initiation fees. Specifically, he wanted to know if adopting ASC 606 Revenue from Contracts with Customers would impact the accounting policies of his local golf club. This post recaps our conversation!

Accounting for Warranties under ASC 606
When the sales clerk asks you if you want to purchase the extended warranty, do you every say “yes?” Have you ever wondered how such warranties are accounted for under U.S. GAAP? This post describes the accounting for assurance-type warranties and service-type warranties under U.S. GAAP

Revenue Recognition: Accounting for Shipping and Handling (ASC 606 / IFRS 15)
Do you look at the cost, or lack thereof, related to shipping and handling when you purchase goods online? In other words, do you value shipping and handling services provided by sellers or resellers of goods? Do you think it should it be considered a separate performance obligation by the seller under the new revenue recognition standard (ASC 606)? Does the accounting treatment differ from that under IFRS 15 (IFRS’s version of the new revenue recognition standard)? In this post, we’ll cover the accounting for shipping and handling activities, specifically whether they should be treated as separate performance obligations under both U.S. GAAP (ASC 606) and IFRS (IFRS 15).

Accessing Collectibility under ASC 606: When Good Contracts Go Bad
ASC 606 requires us to consider collectibility to determine if a contract exists but what happens if things change after the contract is signed? Can the company continue to recognize revenue? This post discusses assessing collectibility under ASC 606 and what to do when good contracts go bad.

Consideration of a Significant Financing Component under ASC 606
Did you know that ASC 606 requires consideration of a significant financing component when determining the transaction price for revenue recognition? This post explores when and how that significant financing component should be recognized.

ASC 606: Tesla’s Rev Rec for Cars and Software
Some cars now require software updates, but how should they be accounted for under U.S. GAAP? This post covers Tesla cars, software updates, and the accounting under ASC 606 Revenue from Contracts with Customers.

IFRS 15 Practice Issue: Training Costs to Fulfill a Contract
IFRS 15 Revenue from Contracts with Customers has been effective for a while now, but with any new standard, particularly one as comprehensive as IFRS 15, certain practice issues arise. This post discusses how to account for training costs incurred to fulfill a contract.