Definition
ASC 606 applies a five-step model to revenue from contracts with customers. Step 1 identifies the contract (approval, rights, payment terms, commercial substance, probable collection). Step 2 identifies the performance obligations. Step 3 determines the transaction price. Step 4 allocates the price to obligations, generally by relative standalone selling price. Step 5 recognizes revenue when or as control of each obligation passes to the customer, at a point in time or over time.
Why it matters in an audit or review
Auditors walk through each step for significant revenue streams, test controls over contract review, and obtain evidence that revenue meets the criteria in the period. Judgments in step 2, step 3, and step 5 draw the most scrutiny. Disclosures cover disaggregation of revenue, contract balances, and significant judgments.
Example
(Illustrative) A software company signs a $120,000 one-year license with support. Step 1 contract confirmed. Step 2 license and support are distinct. Step 3 price is $120,000. Step 4 allocates, say, $90,000 to the license and $30,000 to support based on standalone prices. Step 5, assuming the license is a right to use the software, recognizes $90,000 at delivery and $2,500 a month for support ($30,000 / 12).
Common mistakes
- Skipping the contract existence criteria for questionable customers.
- Allocating by invoice amounts instead of standalone selling prices.
Sources
- FASB ASC 606-10-25, Revenue from Contracts with Customers, Recognition
- FASB ASC 606-10-32, Transaction price and allocation
- FASB ASC 606-10-55, Implementation guidance, licensing
Definitions paraphrase AICPA and FASB guidance; read the standard itself before relying on a requirement. Example figures are illustrative. This page is guidance, not professional advice. Report an error