REVENUE RECOGNITION: 5-Step Model, Performance Obligations, Examples
- Graziano Stefanelli
- 2 days ago
- 2 min read
Revenue is recognized when control of goods or services transfers to the customer—not when cash is received.
The 5-step model under ASC 606 and IFRS 15 ensures consistency across industries and contract types.
1. The 5-Step Revenue Recognition Model
Step | Description |
1 | Identify the contract with the customer |
2 | Identify performance obligations in the contract |
3 | Determine the transaction price |
4 | Allocate the transaction price to the performance obligations |
5 | Recognize revenue as each performance obligation is satisfied |
2. Step 1 – Identify the Contract
A contract must:
Be approved by all parties
Create enforceable rights and obligations
Have identifiable payment terms
Have commercial substance
Be probable the entity will collect the consideration
3. Step 2 – Identify Performance Obligations
A performance obligation is a distinct good or service (or bundle) promised to the customer.
Indicators of distinct performance obligations:
The good/service provides a separate benefit
It can be transferred independently
Example
In a phone contract:
Handset = one obligation
Monthly service = another obligation
4. Step 3 – Determine the Transaction Price
This is the amount of consideration expected in exchange for fulfilling the contract.
It includes:
Fixed amounts
Variable amounts (bonuses, penalties)
Non-cash consideration
Consideration payable to the customer (e.g. rebates)
Adjust for:
Time value of money (if significant)
Constraint on variable consideration (only include amounts likely to be realized)
5. Step 4 – Allocate the Price
If multiple performance obligations exist, allocate the transaction price based on standalone selling prices.
Example:
Total price = $1,200
Service: normally sold at $900
Equipment: normally sold at $300Allocation:
Service = 75% of $1,200 = $900
Equipment = 25% of $1,200 = $300
6. Step 5 – Recognize Revenue
Revenue is recognized when (or as) control of the good or service transfers to the customer.
Type | Timing of Recognition |
Point in time | Upon delivery or transfer of control |
Over time | If the customer simultaneously receives benefit (e.g., services) |
Over time criteria include:
Customer controls the asset as it’s created
Performance creates an asset with no alternative use
Entity has enforceable right to payment
7. Real-World Examples
Software license:
One-time perpetual license = point in time
SaaS subscription = over time
Construction contract:
Long-term project with progress billing = over time (using input/output methods)
Retail sale:
Revenue recognized at point of sale/delivery
8. Disclosures
Financial statements must explain:
How revenue is recognized (timing and method)
Disaggregation of revenue (e.g., by geography, segment, contract type)
Contract balances: receivables, contract assets, and contract liabilities
Significant judgments and changes in estimates
Key take-aways
Revenue is recognized based on performance, not cash receipt
The 5-step model applies across industries under ASC 606 and IFRS 15
Correctly identifying obligations and timing prevents misstated income
Disclosures enhance transparency and comparability across reporting periods
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