Chapter 8 — Step 5: Determine When to Recognize Revenue

8.1 Objective and Background

ASC 606-10

25-23 An entity shall recognize revenue when (or as) the entity satisfies a performance obligation by transferring a promised good or service (that is, an asset) to a customer. An asset is transferred when (or as) the customer obtains control of that asset.

8.1.1 Concept of Control

In a manner consistent with the core principle of the guidance in ASC 606, as stated in ASC 606-10-10-2 — “an entity shall 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” (emphasis added) — step 5 focuses on recognition (i.e., when it is appropriate to recognize revenue). While steps 1 and 2 (see Chapters 4 and 5) also contain recognition concepts, step 5 is the central tenet of the recognition principle in the standard.

The revenue standard requires an entity to assess whether the customer has obtained control of the good or service to determine whether the good or service has been transferred to the customer. Determining when revenue should be recognized — that is, the timing of the transfer of control of the good or service to the customer — is the most common question regarding revenue recognition.

While step 5 of the standard’s revenue model acts as a gate and responds to the question of “when to recognize,” it is preceded by the earlier steps (i.e., steps 1–4). The conclusions reached in the earlier steps are critical to the determination of how much revenue to recognize in step 5 when control of a good or service is transferred to a customer. Therefore, the revenue standard generally requires a sequential evaluation of each of the four steps preceding step 5.

Connecting the Dots

While the revenue standard uses a control-based approach for determining whether and, if so, when a good or service has been transferred to a customer, the FASB and IASB did not define “good or service.” Instead, the boards focused on the concept of control to determine when the good or service is transferred. The boards decided that assessing the transfer of control would result in more consistent decisions about when goods or services are transferred than the risks-and-rewards approach, which requires an entity to use more judgment when it retains risks and rewards to some extent. For example, the boards considered contracts in which the entity sells a product but also provides a warranty. During the development of the final standard, this example was used to challenge the risks-and-rewards model since some argue that in many such cases, the risks and rewards of the product may not have been entirely transferred to the customer given that the entity retains some risks associated with the product through the related warranty. However, it was the boards’ expectation that under a control-based model, the accounting would more appropriately align recognition with performance — that is, in the fact pattern above, the entity performs by delivering a product and then, if the warranty is determined to be a service-type warranty (see Section 5.5), will recognize performance under its separate promise of a warranty over the period covered.

The revenue standard requires an entity first to determine, at contract inception, whether control of a good or service is transferred over time; if so, the entity would recognize the related revenue over time in a manner consistent with the transfer of the good or service over time to the customer. If the entity cannot conclude that control is transferred over time (i.e., the transfer does not meet one of three criteria described in Section 8.4), control is considered to be transferred at a point in time. As a result, the entity must determine at what specific point in time to recognize the related revenue. As discussed in Section 8.6, the guidance provides five indicators to help an entity assess when that point in time is for a promised good or service. Even though the revenue standard shifts away from risks and rewards, the boards noted that an entity could still look to whether risks and rewards have been transferred to the customer as an indicator that control has passed to the customer.

8.1.2 Performance Obligations Satisfied Over Time or at a Point in Time

ASC 606-10

25-24 For each performance obligation identified in accordance with paragraphs 606-10-25-14 through 25-22, an entity shall determine at contract inception whether it satisfies the performance obligation over time (in accordance with paragraphs 606-10-25-27 through 25-29) or satisfies the performance obligation at a point in time (in accordance with paragraph 606-10-25-30). If an entity does not satisfy a performance obligation over time, the performance obligation is satisfied at a point in time.

One of the key objectives of the FASB and IASB in establishing the revenue standard was to create a single framework for entities to apply across disparate jurisdictions, industries, and transactions. However, there had been a long-standing view that some promises to a customer are satisfied in an exchange transaction at a point in time (generally, the transfer of a good), whereas other promises to a customer are satisfied over time as the entity performs various actions (generally, the transfer of a service). When developing the control-based model, the boards thought that using control as the basis for recognition allowed them to achieve that single model since control of something could be transferred (1) at a single point in time after the completion of the entity’s efforts or (2) over time in conjunction with the entity’s efforts toward providing a benefit to the customer, typically through the delivery of a service.

During the development of the revenue standard, the boards understood, and stakeholders continued to provide feedback on, the need to outline how the single model of control would be applied to the transfer of goods as compared with the transfer of services.

8.1.3 Distinguishing Between “Goods” and “Services”

Despite intending to create a single framework, the boards acknowledged that there are clear differences between the most common instances of sales of goods and delivery of services. However, along a spectrum of revenue transactions, there are instances of arrangements (e.g., construction-type contracts) in which it becomes less clear whether the entity is providing a good or a service because constructing an asset has attributes of both the sale of a good (the final constructed asset) and the delivery of a service (benefits are being provided throughout the development of the asset).

Therefore, the boards committed to developing a control-based model and determined that it would be most appropriate to describe performance obligations as being transferred either over time (most commonly in the case of services) or at a point in time (most commonly in the case of products or goods).

During the development of the revenue standard, stakeholders questioned whether a control-based model could be applied to service contracts given that it can be difficult to identify the asset that is being provided to the customer in a service contract. Such difficulty arises because the asset is often simultaneously created and consumed by the customer, especially in the case of a pure service contract (e.g., cleaning service). As a result, stakeholders expressed concerns about whether a single control-based model could be applied to all types of contracts with customers. The boards clarified that although certain service contracts may not result in the creation of a tangible good or work in process, there is an inherent asset being created in all service contracts (i.e., the customer receives a future economic benefit as a result of the entity’s performance in a service contract). In light of this, the boards decided that a separate model should not be created for service contracts and continued to develop a single control-based model.

Ultimately, the boards achieved their objective of creating a single framework for revenue recognition based on control (specifically, when the customer obtains control of an asset) while still allowing for accounting based on the disparate qualities of goods and services.

See further discussion in Sections 8.4, 8.5, and 8.6 of performance obligations satisfied over time and at a point in time.

Also, the boards determined that it was most operational to make the distinction between a performance obligation satisfied at a point in time and a performance obligation satisfied over time by using a single starting point — namely, the determination of whether the promise is a performance obligation satisfied over time, as discussed in Sections 8.4 and 8.5. That assessment is based on whether the performance obligation meets one of three specific criteria for recognizing revenue over time. If the promise does not meet any of the three criteria, it is, by default, a performance obligation satisfied at a point in time, as discussed in Section 8.6.

It is important to note that the assessment of whether a performance obligation meets the criteria for recognizing revenue over time must be performed at contract inception. In addition, the assessment of whether revenue should be recognized over time or at a point in time should be performed at the individual performance obligation level rather than at the overall contract level. Accordingly, it is important to appropriately identify the performance obligations in step 2 (refer to Chapter 5) before evaluating whether revenue should be recognized over time or at a point in time.

The simple flowchart below illustrates the process that entities should use to determine the appropriate pattern of revenue recognition.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.