INTRODUCTION

When there is a significant change in our economy it will trigger also a change in the accounting
standards. This also means adapting to the changes will result to new processes and new
methods. As a reaction to the trend in the ways of earning and gathering data, last May 28,
2014, the FASB and the International Accounting Standards Board (IASB) issued (press
release) converged guidance on recognizing revenue in contracts with customers. The new
guidance is a major achievement in the Boards’ joint efforts to improve this important area of
financial reporting. We cannot completely say it’s the last evolution of the standard but when it is
necessary, time will come that a new standard will arise.

By the end of this semester you should be able to:

• Summarize and compare the difference between the old revenue recognition principle
and new revenue recognition principle.
• Apply your skill in using the 5 Step Model revenue recognition on every situational
problem.

Discussion

What Is Revenue Recognition? Base on GAAP, Revenue recognition is the principle

that identifies the specific conditions in which revenue is recognized and determines
how to account for it. Typically, revenue is recognized when a critical event has
occurred, for example a sale of an inventory. The revenue should be recorder when the
item has been transferred to the buyer. This situation also includes any other form or
way of transferring the risk and reward of the item sold. Also cited in the GAAP, the
amount is easily measurable to the company for purpose of recording.

The old standard for revenue accounting is fairly straightforward when a product is sold,
and the revenue is recognized when the customer pays for the product. However,
accounting for revenue can get complicated when a company takes a long time to
produce a product. As a result, there are several situations in which there can be
exceptions to the revenue recognition principle.

The revenue recognition principle features accrual basis accounting, this means it
requires that revenues should recognized on the income statement in the period when
realized and earned—not necessarily when cash is received. Realizable means that
goods or services have been received by the customer, but payment for the good or
service is expected later. Earned revenue accounts for goods or services that have
been provided or performed, respectively.
Revenue Recognition based on PFRS 15 (Philippine Financial Reporting
Standards)

Revenue recognition is an accounting principle that outlines the specific conditions

under which revenue is recognized. In theory, there is a several ways or potential points
at which revenue can be recognized.

Steps in Revenue Recognition from Contracts

This part will be the explanation of each step.

 1. Identifying the Contract

A revenue or sale transaction will sometimes require a contract. If a transaction will

require a contract, all conditions below must be satisfied for a contract to form:

 Both parties must have approved the contract (whether it be written, verbal, or
implied).
 The point of transfer of goods and services can be identified.
 Payment terms are identified.
 The contract has commercial substance.
 Collection of payment is probable.

2. Identifying the Performance Obligations

Performance obligation pertains to the goods or service to be transferred to complete

the sales contract. Some contracts may involve more than one performance obligation.
For example, the sale of a car with a complementary driving lesson would be
considered as two performance obligations – the first being the car itself and the second
being the driving lesson. A sale of a motorcycle with inclusions like registration, helmet
and jacket mean there are three to four performance obligations.

Performance obligations must be distinct from each other. It doesn’t mean detachable
physically but can be identified separately. The following conditions must be satisfied for
a good or service to be distinct:

 The buyer (customer) can benefit from the goods or services on its own.
 The good or service is separately identified in the contract.

Here are examples of transactions and identified performance obligation

TRANSACTION PERFORMANCE OBLIGATION
A contract to buy a personal computer set PC set, Operating system, Computer
Applications
A transaction to operate a business Store site, Franchise license, equipment,
name(franchise) training of staff, seminar, machinery
Purchase of a software Software license, software updates and
other data for running the software

3. Determining the Transaction Price

The transaction price is usually readily determined; most contracts involve a fixed
amount. For example, a price of P 20,000 for the sale of a car with a complementary
driving lesson. The transaction price, in this case, would be P20,000. A landscaping
engagement with monthly trimming ang grooming of plants worth P 30,000. The bundle
price must be stated in the contract.

4. Allocating the Transaction Price to Performance Obligations

The allocation of the transaction price to more than one performance obligation should
be based on the standalone selling prices of the performance obligations. The
standalone selling price is the price at which the entity would sell a promised good or
service separately to a customer. The new revenue standard requires that all
standalone selling prices be estimated if the selling price is not readily observable.

For example, a contract involves the sale of a car with a complementary driving lesson.
The total transaction price is P 1,800,000. The standalone selling price of the car is P
1,500,000 while the standalone selling price of the driving lesson is P 20,000. The
transaction price allocation would be as follows:
 Performance Standalone % of total X Transaction Allocated
Obligation price price amount
Car 1,500,000 98.69% x 1,800,000 P 1,776,420
Driving Lesson 20,000 1.31% X 1,800,000 P 23,580
Total 1,520,000 100% 1,800,000

The allocated amount is our goal here. This will be the amount you will record in the
journal entry as revenue from the transaction. Step no 5 will be your guide if you will
record the allocated amount as income or deferred income.

Note: The percentage of the total is simply the standalone price divided by the total
standalone price. For example, the percentage of total for the car would be calculated
asP19,000 /P20,000 = 95%.

 5. Recognizing Revenue in Accordance with Performance

Recall the conditions for revenue recognition. Conditions (1) and (2) state that revenue
would be recognized when the seller has done what is expected to be entitled to
payment. Therefore, revenue is recognized either:

At a point in time Income is earned only once and at a

specific time. Either at the start of the
contract, when the item is delivered, when
the contract ends or any other possible
date specified in the contract.
Over time Income is earned evenly. That means you
will divide the allocated price using the life
of the contract and recognize income per
year. (Just like straight line depreciation)

Over time At a point in time.

In the example in no 4, the revenue associated with the car would be recognized at the
point in time when the buyer takes possession of the car. On the other hand, the price
for the driving lesson will be earned every time there is a driving lesson session. Let us
say the total number of session is 5 times once a week, P 23,580/5= 4,716 per week is
the revenue for providing the service.
The revenue recognition journal entries for the two performance obligations (car and
driving lesson) would be as follows:

ENTRY ON THE DATE OF PURCHASE

Cash 1,800,000
Revenue 1,776,420
Deferred Revenue 23,580

WEEKLY ENTRY
Deferred Revenue 4,716
Revenue 4,716

End of Discussion