As noted in our prior blog post, new revenue recognition standards were issued in 2014. The first step of the new revenue recognition standard is to identify the contract(s) with a customer. A contract with a customer must meet all of the following criteria:
The contract may be written, verbal or implied by customary business practices. The enforceability of the rights and obligations in a contract are a matter of law and vary across legal jurisdictions, industries and entities. An entity should consider these practices and processes in determining when an agreement with a customer creates enforceable rights and obligations of that entity.
A contract does not exist if each party has the unilateral enforceable right to terminate a wholly unperformed contract without compensation to the other party. A contract is wholly unperformed if both of the following criteria are met:
If an organization receives consideration from a customer, and a contract with a customer does not meet the criteria to be considered a contract under revenue recognition, the entity should recognize the consideration received as revenue only when either of the following events occur:
If one of the above criteria is not met, the organization should record the consideration received as a liability until a contract exists or one of the above criteria is met.
There is also an option to combine two or more contracts entered into at or near the same time with the same customer, and account for them as one contract if they meet the following criteria:
In addition, in this step entities must also determine whether or not it is probable that the consideration to which it is entitled will be collected. This includes considering the customer’s ability and intention to pay the consideration when it is due. If it is not probable that an organization will collect the consideration, then revenue will not be recognized until payment is collected from the customer.
In our next post, we will cover how to identify the performance obligation in a contract. Read other articles in our “Revenue Recognition” Series: