When a company must recognize revenue, the company is figuring out when it’s okay to put that income on their books. A company should recognize revenue when the provider of the product or service has satisfied their performance obligations.
There are five steps to recognizing revenue.
A contract must be identified
It is important to remember that the contract does not have to be on paper. For example, when you order a meal at a restaurant the restaurant does not compose a paper contract that states what they will provide for you. It’s more of an agreement between the two parties. Finally, we must remember that a contract is not valid if one of the parties is unable to do satisfy the contract
The performance obligations must be stated.
The contract must state what the seller must do to earn the revenue. This can include a product or service over a specific period.
The transaction price must be determined.
Both parties, included in the contract must come to an agreement on how much money/asset will be given once the performance obligations have been met. If the contract is expected to be active for more than a year, the amount must be calculated at present value.
The transaction price must be broken out into each of the performance obligations.
After the transaction price has been established, the price must be divided into each performance obligation.
The company can now recognize revenue.
Once all of these steps have been fulfilled the seller can go ahead and put the revenue on their books.
